Management Accounting Guide

Chartered Accountants Program Management Accounting & Applied Finance
ACT
Unit 1: Management accounting and

strategy
Activity 1.1
Attributes of a management accountant
Introduction
This activity links to unit learning objective:
• Describe the role that the management accounting and treasury functions play within
an organisation.
At the end of this activity you will be able to describe the role of a management accountant
within an organisation.
It will take you approximately 30 minutes to complete.
Scenario
You plan to qualify as a Chartered Accountant and are interested in what employers are looking
for when employing management accountants or business analysts.
Task
Obtain two job descriptions for vacancies as management accountants or business analysts. List
the required attributes, using the following categories:
1. Relationships (how I relate)
2. Intellect (how I think)
3. Mindset (who I am)
4. Expertise (what I have)
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Unit 1 – Activities Page 1-1

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ACT
Solution
Your answer will likely be different to the one below. Note that the aim of this activity is to help
increase your awareness of the attributes that need to be developed in order for you to become a
successful management accountant or business analyst.
Relationships (how I relate)

Employ effective communication and presentation skills. (alternatives could include the
following: actively listen, respond in a timely manner, getting everyone on the same page, being
present and available, allow your values to shine through)
Build relationships to enhance collaborations in and beyond the workplace.
Professional communication manner.
Well-developed communication and interpersonal skills.
Stakeholder management skills; the ability to communicate across multiple levels of an
organisation.
You are confident, outgoing and a team player.
Intellect (how I think)

Analyse and apply logical reasoning to complex financial situations and problems to inform
decision making and make sound conclusions.
Ability to make commercial decisions that positively impact on financial business outcomes.
You are keen to learn and quick to pick things up.
Solve business problems.
Mindset (who I am)

Demonstrate courage in taking ethically appropriate actions.
Use scepticism in applying questioning and assessment techniques to problems, data,
information and results.
Responsible, patient and able to work under pressure.
Expertise (what I have)

IT skills for data interrogation, synthesis and analysis to perform key work functions.
Skills to perform business modelling and forecasting using the contemporary financial
modelling technologies.
Strong analytical, investigative and problem-solving skills along with the ability to interpret
data and issues.
Ability to use financial accounting software.
Strong organisational, planning and time management skills with an ability to prioritise and
manage workload, meet deadlines.
Professional skills (soft skills).

ACT
Activity 1.2
The role of the treasury function
Introduction
As organisations grow, the role of the treasury function changes and develops. The skills and
resources required to run an organisation are also refined, and in such environments accountants
need to be able to advise on the most practical and appropriate organisational structures.
• Describe the role that the management accounting and treasury functions play within
an organisation.
At the end of this activity you will be able to describe the alternatives available to businesses to
structure their treasury functions.
Scenario
This activity is based on the SDT Solutions (SDT) case study.
You are a consultant, working for the CFO, Charlene O’Shay.
Richard Waugh, Philip McCaw and SDT’s board are examining the purchase of a business in the
USA. The objective of this acquisition is to continue the growth of SDT.
The US organisation has a slightly different business model to SDT: it regularly provides
services in other North American countries (i.e. Mexico and Canada), with invoices issued in
the local currencies.
SDT expects to finance this acquisition through a mix of equity (cash provided from Australia)
and debt funding in the form of rolling 90-day bank bills provided by a local US bank. Both
Richard and Philip plan to be directly involved in the management of the US business to ensure
that required targets are met and strong central control is maintained over the North American
operations until the business there is firmly established.
The finance/risk committee is considering the implications of the subsequent integration, which
would make the combined business large enough to have a treasury function.
Task
For this activity you are required to prepare a recommendation for the finance/risk committee
on the treasury structure for SDT. Advise SDT on the applicability of each of the following
treasury structures at SDT:
– Outsourced.
– Centralised.
– Decentralised.

Management Accounting & Applied Finance Chartered Accountants Program
ACT
Solution
The following is advice on the applicability of the various treasury structures at SDT:
Outsourced treasury structure – As SDT has indicated that it wants to maintain control,
outsourcing is not the preferred structure despite outsourcing capability to monitor markets
24 hours a day if required and across SDT’s three time zones.
Centralised treasury structure – A preferable structure for SDT as it would provide head office
control of group risks and facilitate optimum cash flow; however, consideration should be given
to the fact that the organisation would be operating in three different time zones.
Decentralised treasury structure – This structure would provide a quicker response to local
management based on a superior understanding of their needs however it will not provide the
level of control stipulated, and so it would not be the best alternative. Another consideration is
whether sufficient work exists to justify separate treasury management functions in the US and
Australia/NZ.
Recommendation – Given the current management’s desire for control, the size of SDT and the
expected level of transactions to be undertaken, it is recommended that SDT adopt a centralised
treasury function.
Recommended approach
The steps outline a recommended approach for successfully completing this task.
Step 1 – Consider the applicability of the treasury structures

In order to consider the applicability of each of the treasury structures, an understanding of
the definition of ‘outsourced’, ‘centralised’ and ‘decentralised’ (refer to the CSG content) is
necessary. This can then be aligned with information from the SDT case study and documented.
Outsourced treasury structure

Outsourcing the treasury function could be a viable alternative, given the fact that the
organisation would be operating in three different time zones, and the function may not be a
full-time requirement. An outsourced treasury function would have the capability to monitor
the markets 24 hours a day, if required. SDT would be responsible for setting the policies under
which the outsourcing operates, but not how they are implemented.
However, as SDT has indicated that it wants to maintain control, outsourcing is unlikely to
provide the desired outcome.
Centralised treasury structure

This would provide head office control of group risks and facilitate optimum cash flow;
however, consideration should be given to the fact that the organisation would be operating in
three different time zones.
Key issues to be considered are the volume of transactions to be managed, as well as the level of
control required by head office.
Key transactional factors to consider include:
• The USA has invoicing in cross-border currencies in Mexico and Canada.
• Rolling 90-day bank bills (used to finance the US acquisition) are likely to be denominated
in USD.
• The transactions between Australia and New Zealand (fairly stable currency movements).
Note: Discussion on these topic areas is covered in more detail in the unit on business risk.
Page 1-6 Activities – Unit 1

ACT
Richard and Philip have indicated that they intend to be actively involved in the US acquisition
to ensure that desired goals are achieved. This suggests that centralised control is preferred.
Decentralised treasury structure

This would provide a quicker response to local management based on a superior understanding
of their needs; that is, US management and Australian/New Zealand management respectively.
Given current management’s inferior understanding of the US business, they would probably
prefer this structure. However, it will not provide the level of control stipulated, and so it would
not be the best alternative.
SDT also needs to consider whether sufficient work exists to justify separate treasury
management functions in the US and Australia/NZ.
Step 2 – Determine the most appropriate structure for treasury and make
a recommendation
Use the information collated above to recommend the best structure for SDT to adopt; that is,
to adopt a centralised treasury model.

ACT
Activity 1.3
Identifying generic strategies
Introduction
The generic strategy framework developed by Michael Porter is a useful tool to analyse the
competitive strategies of organisations. Understanding an organisation’s strategic goals and
objectives is an important step in adding value as a management accountant to ensure all
analysis and advice is aligned to those objectives.
• Outline generic strategies that organisations use.
At the end of this activity you will be able to outline the characteristics of each of the generic
strategies and identify which strategy is being pursued by an organisation.
Scenario
You have recently applied for a position as a management accountant at Wanderlust Travel
Insurance (Wanderlust), reporting to the CEO, Albert Mangels.
Wanderlust provides budget travel insurance policies exclusively over the internet. It aims to
be Australia’s biggest travel insurance provider and has a limited range of policies targeted at
travellers who want coverage for the essentials (e.g. medical expenses), but not all the extras
(e.g. cover for extreme sports or kidnap and ransom).
Wanderlust boasts that its premiums are 30% lower than the average premium paid by
travellers. Its website is maintained offshore in the Philippines, and its call centre, which
handles customer service (including initial claims enquiries), is based in India.
The actual processing of claims is outsourced to a specialist travel insurance claims provider,
which assesses and manages the claims for a fixed fee per policy sold. The Australian office has
some management, product development, and finance and risk management staff.
You have a job interview with Albert tomorrow and are researching Wanderlust to understand
its business strategy. You want to familiarise yourself with Wanderlust’s business and impress
Albert in the process.
Task
1. For this activity you are required to identify which of Porter’s generic strategies Wanderlust
appears to have adopted. Justify your conclusion.
2. Briefly outline the strategic process that Wanderlust would have gone through before
selecting its strategies.

ACT
Solution
Task 1
Wanderlust has adopted a focused low-cost strategy.
It gains competitive advantage by providing low-cost travel insurance targeted at narrow
segments of the travel insurance market. This allows it to reduce costs and charge a lower
premium than its competitors. The ‘target consumers’ are ‘travelers who just want essentials’.
Wanderlust is not targeting all consumers in the insurance market, i.e. they are not concerned
about travelers who want fancy extras in their policies. As Wanderlust is focusing on a specific
type of consumer implies a focus strategy.
To execute this focused low-cost strategy, Wanderlust has adopted the following operating
processes:
• Established its customer service and website functions in countries with lower labour costs
than Australia.
• Only uses the internet to sell its policies.
• Outsourced claims processing to an external provider under a fixed fee contract.
Task 2
Wanderlust would undertake a strategic process along the following lines:
• Define their destination by developing a vision/mission statement.
• An external analysis would then be undertaken: a tool such as PESTEL analysis could be
used to analyse the macro environment, and Porters Five Forces analysis could be used to
analyse the industry in which Wanderlust operates.
• The next step would be for Wanderlust to undertake a SWOT analysis, this would
incorporate an analysis of both its internal and external environment.
• Wanderlust would then be in a position to generate some strategic alternatives.
Once the above processes have been completed then Wanderlust would be in a position to select
relevant strategies.
The following outlines a recommended approach for successfully completing this task.
• Review the definitions of generic strategies available in the CSG content.
• Consider Wanderlust’s business model and identify how it competes in its market.
• Match Wanderlust’s business model with an appropriate generic strategy to see which
one it is adopting. Remember to consider broad versus narrow (focus) and cost versus
differentiation.
• Identify key factors from the background material to support your conclusion as to which
generic strategy Wanderlust has adopted.
• Review the strategic process including developing of vision/mission statement, external
analysis, SWOT analysis.

ACT
Activity 1.4
Preparing a SWOT analysis and identifying
a generic strategy
Introduction
A SWOT analysis provides a framework for an organisation to establish its strategy
opportunities. Understanding an organisation’s strengths, weaknesses, opportunities and
threats allows a management accountant to add value to an organisation’s strategic goals
and objectives.
At the end of this activity, you will be able to outline the characteristics of each Porter’s generic
strategies and identify which strategy is being pursued by an organisation.
Scenario
You have recently been appointed the management accountant at Mega Butch, a nationwide
company currently owning and operating 40 butchery stores. One of your first tasks is to attend
a meeting of the company’s senior management team to discuss the organisation’s strategy
options. Your research and discussions with relevant staff provides the following information.
Mega Butch is privately owned. Its wealthy owner Pete Lowe, a well-known ex-sportsman, has
been rewarded by the company’s years of strong performance. The company opened its first
store in 1985 and established itself in direct competition to the supermarkets as a super discount
butchery chain with the motto ‘We discount the price, but never the quality’.
The company located its stores in suburbs with a lower socio-economic population. From the
1990s, new stores opened in regions wherever the population size justified their establishment.
Many of the original suburbs where first stores were established have changed demographically
and become more affluent.
Marketing and advertising has always been a strong focus of Pete Lowe. He soon became the
company’s key front person, attending the many community and charity events sponsored and
supported by Mega Butch.
Pete learned the nuances of the trade as a school boy doing part-time work at the local butchery.
Despite his business success, Pete has never been keen on keeping abreast of contemporary
literature relating to management practice and he has no formal qualifications. Like many self-
made entrepreneurs, he has strong views about the ingredients of success. He says: ‘All you
need is a good accountant and a good lawyer. Forget about getting a consultant. Value honesty
and integrity, and know that things like e-commerce and social media will come and go, but
business success is built on trust’.

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Store expansion was significant between 2008 and 2011, with a peak number of 60 stores in
operation. The expansion required significant external funding. However, since the peak of
the expansion, store numbers have declined, and, in 2015, five stores were closed. In 2018,
the company reported its first loss of $2.5 million. This was followed by a reported loss of
$5.4 million in 2019. The company has a 30 June year end.
The supermarkets have continued to gain market share across all food and drink categories over
the past few years. They operate on low margins and high volume. All the major supermarkets
now offer attractive loyalty schemes to encourage large spends from their customers.
The number of online customers continues to grow for supermarkets. Mega Butch has no plans
to expand into offering online ordering.
In 2016, Mega Butch formed an alliance with a major chicken farm. Revenue and profits from
this segment have grown each year since 2016.
In 2018, Pete Lowe expressed the desire to leave Mega Butch with the intention of spending
more time with his family. He is happy to remain as a ‘front man’ for the business but no longer
wants the responsibility and commitment of running it. He sees a change to the business model
in the future: ‘Franchising is definitely the future of my organisation. The main problem is
getting the right people to buy and maintain the franchises’. To date, there has been no progress
in his exit plans.
Task
For this activity, you are required to:
1. Prepare a SWOT analysis of Mega Butch as you prepare for the senior management team
meeting.
2. Briefly outline the generic strategy that Mega Butch appears to have followed to date.
In addition, outline possible future generic strategies the company could pursue.

ACT
Solution
Task 1
The following is a guide to preparing a SWOT analysis for Mega Butch.
Strengths Weaknesses
Mega Butch is a well-established brand with a well- The company has suffered financial losses over the last
known front person. The company name is associated two years. The loss in 2019 was higher than that of the
with the positive values of trust and integrity. These previous year, indicating the losses may be increasing
values are not built up overnight at a higher rate
The company has a strong presence in local Technology changes and progress in this area appear
communities as a result of the years it has been to be a low priority with the owner. This could be
involved in sponsoring and supporting local events having a significant impact on the success of the
business (compared to the online customer growth of
the supermarkets)
The owner, Pete Lowe, knows the industry and the The rapid growth between 2008 and 2011 may have
on-site operations (butchery operations) well through had a negative impact on the business (financial drain)
his vast experience
Pete Lowe appears to be reasonably wealthy and may Pete Lowe has no experience in the franchising model,
be in a position to contribute additional funding if the so he would be relying on sound advice to progress
organisation requires it these developments. His inexperience together with
his lack of awareness and understanding of current
management practices means that a significant
amount of good advice would be required
The number of stores are declining, reducing the

brand’s value and strength that was previously held in
the marketplace
Opportunities Threats
Establish a new model for franchising Mega Butch’s The competition from supermarkets is based heavily
operations, thus supporting the planned exit strategy on supermarkets being the leading cost providers.
for Pete Lowe They are also offering further benefits to customers
through loyalty schemes
Continue to involve Pete Lowe as the front person Any increase in the interest rate could have a
for marketing, advertising and sponsorship, whether significantly negative impact on the business given
under a new franchise model or the current store the funding the company undertook during its
ownership. An alternative is to change the company’s expansion stage between 2008 and 2011
name to one that is more relevant to today’s
customers
Given the success of the strategic alliance with the

chicken farm, investigate further strategic alliances
with suppliers
Task 2
The generic strategy employed by Mega Butch to date has been a broad cost leadership strategy.
The company was established in direct competition to the supermarkets as a super discount
butchery chain. Mega Butch has stores nationwide delivering on the company’s motto of
‘We discount the price, but never the quality’.
A potential future strategy would be to consider changing Mega Butch’s business model of
ownership to a franchising model. This would form part of a focus strategy establishing the
franchise stores as being unique to the local community. The focus would be on the lower socio-
economic areas where the stores were originally intended to be located. Although it is difficult
to compete with the supermarkets, this cost strategy is what Mega Butch was originally built on.
Therefore, there is still value in maintaining this element of the strategy.

ACT
The following outlines a recommended approach for successfully completing this task.
• Review the SWOT framework to provide a SWOT analysis for Mega Butch based on
the scenario.
• Review the definitions of the generic strategies.
• Consider the history of Mega Butch and identify how it has competed in the market.
Match this to an appropriate generic strategy to see which one it has followed.
• Consider the future of Mega Butch and identify how it could compete in the market in the
future. Match this to an appropriate generic strategy to see which one it could adopt.

ACT
Activity 1.5
Managing ethical issues
Introduction
In undertaking their work, accountants in business are likely to encounter ethical dilemmas that
have an impact on themselves, internal stakeholders and occasionally external stakeholders.
Chartered Accountants working in business may be more frequently exposed to situations
where their own personal ethics are challenged. Ethical issues in these cases arise from the
management accountant holding a position that is deeply embedded within the organisation.
Here their behaviour and actions can be influenced by the culture and key performance
indicators (KPIs) of the organisation.
The consequences of a management accountant not acting ethically within a company include
loss of investor faith and exposing the company to reputational risk that could lead to ongoing
viability issues.
This activity links to unit learning objectives:
• Identify professional (ethical) issues that may arise for Chartered Accountants in business.
• Outline relevant ethical standards and appropriate safeguards for ethical issues that arise.
At the end of this activity you will be able to identify ethical dilemmas and outline appropriate
safeguards to manage the threat to fundamental principles.
Scenario
You are a Chartered Accountant and the management accountant at Enterprise Limited
(Enterprise). For the past five years, you have worked as the manager of finance and
administration.
You are currently facing a number of ethical dilemmas.
Ethical dilemmas
Dilemma Details
1 As part of your role with Enterprise, you are responsible for the supplier negotiations for all office
stationery. One of the major suppliers, Max and Max Supplies, has invited you to attend an all-
expenses paid fishing trip, including overnight accommodation and evening entertainment. The
formal invitation stated ‘We want to celebrate with you the achievement of our most profitable year’
Your Max and Max Supplies contact has advised you that CEOs and CFOs from many top
organisations will be attending, so it will be a good opportunity for you to network and to hand
out your résumé
2 You have been to a confidential meeting about the future plans of the company. The plans include
a proposed restructure, which involves closing down a major part of the nearby factory. You
personally know many of the factory workers and some of their financial hardships, as you have
often been used in the past by some of the factory staff as a budget advisor and counsellor
In the meeting, the CFO asked you to prepare cost-saving calculations for the proposed restructure,
including identifying 70% of the factory workers to be included in potential redundancy packages
3 In preparing the current month’s financial results, you notice a material error you have made in a
previous month that no-one has noticed
You have received a warning for careless mistakes in the past

ACT
Tasks
For this activity you are required, for each ethical dilemma, to:
• Describe the key ethical issues.
• Identify the fundamental principle(s) at risk, in accordance with the International Ethics
Standards Board of Accountants’ International Code of Ethics for Professional Accountants
(the Code).
• Identify the key threats to compliance with the fundamental principle(s).
• Describe possible safeguards to eliminate the threats or reduce them to an acceptable level.

ACT
Solution
The following table outlines the issues, principles and threats for each of the dilemmas presented,
and possible safeguards to eliminate the threats or reduce them to an acceptable level.

ACT
Ethical dilemmas
Page 1-20
Dilemma Details Key ethical issue Key fundamental principles Threats Possible safeguards
at risk
1 As part of your role with The extravagance of the event • Objectivity Subsection 112 Self-interest – Section 120.6 A3 (a) • Company policy on
Enterprise, you are responsible to which the supplier has invited accepting gifts
for the supplier negotiations you, and the potential personal • Ensure more than one person
for all office stationery. One gain you could make through is involved with major supply
of the major suppliers, Max networking decisions
and Max Supplies, has invited
you to attend an all-expenses
Management Accounting & Applied Finance
paid fishing trip, including

overnight accommodation
and evening entertainment.
The formal invitation stated
‘We want to celebrate with you
the achievement of our most
profitable year’
Your Max and Max Supplies
contact has advised you that
CEOs and CFOs from many top
organisations will be attending,
so it will be a good opportunity
for you to network and to hand
out your résumé
Chartered Accountants Program
Activities – Unit 1
Ethical dilemmas
Dilemma Details Key ethical issue Key fundamental principles Threats Possible safeguards
at risk
Unit 1 – Activities
2 You have been to a confidential You have personal knowledge • Objectivity – Subsection 112 Familiarity – Section 120.6 A3(d) • Declaration of workplace
meeting about the future plans of the factory workers that • Confidentiality – relationships
of the company. The plans could influence your decision Subsection 114 • Independent review of
include a proposed restructure, about identifying the workers justification of individual
which involves closing down a to be included in potential redundancy packages and
major part of the nearby factory. redundancies. In addition, your
cost-saving calculations
You personally know many of cost-saving calculation could be
the factory workers and some influenced by your familiarity
of their financial hardships, as with the factory and its workers
you have often been used in
the past by some of the factory
staff as a budget advisor and
counsellor
In the meeting, the CFO
asked you to prepare cost-
saving calculations for the
proposed restructure, including
identifying 70% of the factory
workers to be included in
potential redundancy packages
3 In preparing the current month’s You may hide the material error • Professional competence • Self-interest – • Create a climate/culture
financial results, you notice a or tell someone what you have and due care – Section 120.6 A3(a) where people are
material error you have made in found Subsection 113 • Self-review – encouraged to admit their
a previous month that no-one • Integrity – Section 120.6 A3(b) errors and learn from them
has noticed Subsection 111 • Adequate and timely review
You have received a warning for of all work
careless mistakes in the past
Page 1-21
ACT
ACT
The following outlines a recommended approach for successfully completing the tasks:
• Read each ethical dilemma given and try to identify the key ethical issues being presented.
• Referring to the the Code:
– Identify the fundamental principles at risk (Part 1 subsections 111 to 115) – Integrity;
Objectivity; Professional Competence and Due Care; Confidentiality; Professional
Behaviour.
– Identify the key threats sections R120.6 – self-interest threat; self-review threat; advocacy
threat; familiarity threat; intimidation threat.
– Identify possible safeguards sections R120.10.

ACT
Unit 2: Managing business risk
Activity 2.1
Identifying non-financial business risks
Introduction
Businesses are exposed to a variety of risks from both internal and external sources.
Managing risk is an important skill and management accountants are often called upon to
identify risks and how they may arise as a part of the risk management process.
What is important to understand is that the ability to identify risks confidently and efficiently is
the first stage in being able to manage risks competently within a risk management framework.
• Identify common business risks to which an organisation may be exposed.
At the end of this activity you will be able to correctly identify non-financial business risks to
which a manufacturing business may be exposed.
It will take approximately 30 minutes to complete.
Scenario
This activity is based on the Accutime Limited (Accutime) case study.
You are the new group head of management accounting employed by Accutime. Graham
Anderson, the CFO, has asked you to assist the executive team of Accutime as it completes a
risk review of Accutime’s operations.
Tasks
For this activity you are required to:
1. Identify the key strategic risk facing Accutime and explain your response.
2. Identify and explain the strategic risks Accutime faces with its joint venture operations in
Malaysia and China.
3. Provide examples of how Accutime could face:
(a) reputational risk
(b) compliance risk.
4. Identify four (4) operational risks in the operations of the ‘clean room’ at the Sydney plant.
Explain the potential implication of each of the risks on Accutime’s operations.
maaf12102_act_01

ACT
Solution
1. Accutime’s specific business strategies include:
• Continuing to develop industry-leading quartz crystal-based products.
• Continuing to develop new production and test equipment.
To achieve this, Accutime must continue to develop leading industry innovations in

products and production technology.
The key strategic risk is the loss of innovation momentum. Without this, Accutime will not
be able to achieve its objectives and future profits will be impacted. Competitors will be able
to obtain a greater share of the market.
2. In looking to develop and expand, Accutime has established two joint ventures – one in
Malaysia and another in China (most recently).
First, there is a strategic risk that some of Accutime’s competitive advantage will be
compromised as a result of this expansion, as the advantage it has with its technology and
knowledge is being shared with others. This sharing might lead to knowledge seepage in
what has been identified as a highly competitive market.
Second, there is also some strategic risk in investing in developing economies such as
Malaysia and China where corporate regulations and business practices may vary from
Western practices. However, this potential risk is balanced by greater potential reward, and
given impetus by the risk of being ‘left behind’ competitively if the organisation did not
actively become involved in these growth economies.
3. For reputational risk Accutime examples include:
• Issues with defective products being supplied. The risk here is that customers may be
lost due to defective products and profits will be impacted. The Accutime brand is well
known.
• Inappropriate work practices in business units that might have lower standards than
those in Europe or Australia. Stakeholders opposed to such practices may withdraw
support for Accutime, be it in the form of equity or purchases.
For compliance risk Accutime examples include:

• Accutime is an ASX-listed entity; therefore, it would need to comply with the ASX
listing rules, the Corporations Act and ASIC requirements.
• Environmental standards need to meet country-specific laws regarding minimising
environmental impact.
• Employment law – for example, the Fair Work Act within Australia.
• Quality standards – while not specifically stated, Accutime as a manufacturer may need
to meet quality assurance standards.
• Work Health and Safety legislation and its equivalent in other countries.
• Taxation obligations in Australia and other jurisdictions.

ACT
4. Examples of operational risks within the ‘clean room’ include:
Risk Potential implication on operations
Room becomes contaminated • Production is disrupted while room is decontaminated

• Tainted products produced – resources wasted
• Tainted products produced and not detected, then
unwittingly sold to customers
Power surge causes robotic equipment to • Production is disrupted

malfunction • Faults in products produced
Robotic equipment breaks down • Production disrupted
A mistake is made by a technician in finishing, • Defective product – resources wasted

mounting or gluing • Potentially sold to customers, thus tarnishing reputation
A crystal is not tested before leaving the room • Defective product produced and sold
A defective crystal is not detected when tested • Defective product produced and sold
The following outlines a recommended approach for successfully completing the tasks.
Task 1
To identify the key strategic risk facing Accutime, you must refer to the CSG content and apply
the definition of strategic risk to Accutime. Examples of strategic risks can be found within the
CSG content of this unit.
Reading the case study on Accutime will provide information to identify the key strategic risk.
Your explanation should include reference to the case study.
Task 2
Using the knowledge you obtained on strategic risk in Task 1, read the case study on Accutime
regarding the joint operations in Malaysia and China.
Your explanation should include reference to the case study.
Task 3
The definitions of reputational risk and compliance risk are contained within the CSG content
of this unit, together with examples. These examples should only be used where they are
appropriate to the case study.
Task 4
To identify the operational risks within the ‘clean room’, you must refer to the CSG content and
apply the definition of operational risk to the ‘clean room’.

ACT
Activity 2.2
Identifying financial risks in an organisation
Introduction
Part of a management accountant’s role is to aid management to understand and, where
appropriate, develop treatment plans to deal with the risks that their organisation is exposed
to. In particular, they need to help identify financial risks so that they can advise management
on appropriate policies and procedures, including the use of hedging strategies, with a view to
improving organisational performance.
For this activity you are required to identify and explain the potential financial risks an
organisation may be exposed to.
At the end of this activity you will be able to identify financial risks within a business and
explain how the risks arise.
Scenario
You are a Chartered Accountant working for SDT and you report to Charlene O’Shay (CFO).
The finance/risk committee at SDT has decided that the company has grown large enough to
need the implementation of a risk management framework.
Charlene has been tasked with devising and implementing it.
Task
For this activity you are required to identify and explain the potential financial risks faced
by SDT.

ACT
Solution
Considering each of the six categories of financial risk and their applicability to SDT, the
following conclusions could be drawn:
Financial risks at SDT
Financial risk category Explanation
Liquidity risk Liquidity risk appears low. The company’s working capital position is extremely solid,
with a current ratio of 1.63:1, and cash at bank and on deposit of $2.4 million. SDT’s
balance sheet position is strong and therefore it should be able to raise debt funding
if required for future plans
Credit risk The company’s accounts receivable total is $3.7 million, which represents
approximately half the book value of total assets. Debtor days are approximately
57.5*, which appears high; however, given the nature of its clients (larger corporates
in banking and mining, plus state and federal governments), the chance of default is
likely to be low. A review and ageing of receivables may reveal more information
Equity risk Given that SDT has no investments in listed entities, it has no exposure to equity risk
Commodity risk Given that SDT is a serviced-based organisation, it has no exposure to commodity
risk
Interest rate risk The company’s balance sheet shows no short-term or long-term external debt,
so interest rate risk relating to debt is not present. There is a term deposit of
AUD500,000, so there may be interest rate risk relating to income from this
investment should there be a fall in interest rates
Exchange rate risk Due largely to its operations in New Zealand, SDT is subject to foreign exchange
risk exposure. This exposure relates to loans (AUD850,000), investments (NZD1,000),
and returns on these assets. The AUD/NZD exchange rate is relatively stable, and
therefore, this risk would be considered low
* Debtor days are discussed in Unit 6 and are calculated as ($3,740,078 × 365) / $23,705,637 = 57.59 days.
Noting that the debtors figure was not averaged in this instance as there is only one year of financial
information available.
The following steps outline a recommended approach for successfully completing the task.
Step 1 – Review the categories of financial risk within the CSG content
Step 2 – Review the SDT case study

Identify financial risks associated with SDT’s operations.
Step 3 – Document the applicable risks

Explain why the risks identified in Step 2 are applicable to SDT and present your information.

ACT
Activity 2.3
Using different risk treatments
Introduction
There are a variety of risk treatments available to management accountants to address the
diversity of financial risks faced by organisations. Management accountants need to be able to
think outside the box to find the most appropriate risk treatment given the organisation’s risk
appetite and the circumstances in which the risk arises.
For this activity you are required to identify the risks arising in a given scenario and
recommend the most appropriate risk treatment.
• Assess business risks for an organisation and apply strategies to treat these risks.
At the end of this activity you will be able to identify financial risks in a given scenario and
recommend hedging strategies, including derivative tools and other risk treatments.
Scenario
You are the group treasurer working for KDY Contractors Limited (KDY) reporting to the CEO,
Dan Crothers. KDY is listed on the Australian Securities Exchange and provides engineering
and construction services on a global basis. Its major clients include governments and mining
companies. KDY has a low appetite for risk, and actively identifies key risks linked to each new
contract, and applies appropriate risk treatments.
KDY has been awarded a contract by the New Zealand Government to upgrade Greymouth
Harbour in the South Island. The fixed price of this contract has been set at NZD25 million,
with project completion within 18 months. Progress payments will be received by KDY upon
completion of various milestones detailed in the contract. Before work commences you, as
group treasurer, are to evaluate the issues to be addressed arising from the contract. Interest
rates are expected to increase over the next two years. The AUD has weakened from 1 AUD
= NZD 1.12 three months ago to a current rate of 1 AUD = NZD1.03. It is not clear whether
this trend will continue, there are indications that the AUD will strengthen against the NZD
going forward.

ACT
Tasks
1. Determine in which market the working capital for this contract should be financed. Justify
your response.
Note: Working capital is needed to cover the construction costs incurred in undertaking
the project.
2. Having decided where to fund the working capital using a short-term loan, identify the
remaining financial risks of the contract and recommend appropriate risk treatment(s)
for each.
3. Upon successful completion of the project KDY will transfer the profits back to Australia,
giving rise to exchange rate risk. Recommend an appropriate risk treatment for this
transaction.

ACT
Solution
1. The working capital should be financed in the New Zealand market. On this basis, the
funds to finance the working capital, the finance costs, the expenditure incurred to complete
the project, and the revenue received throughout would all be in the same currency, thus
forming a natural hedge.
2. Having reviewed the contract, you have identified credit risk and interest rate risk.
• Credit risk – Given that this risk would be ranked very low due to the credit rating of
the New Zealand Government, the recommended appropriate treatment would be to
accept the risk.
• Interest rate risk – The appropriate risk treatment would be to either enter into a fixed
interest rate loan or to use a forward rate agreement (FRA). Both can be used to lock
in the rate in a rising interest rate environment and so align with KDY’s low appetite
for risk.
3. As there is uncertainty regarding the AUD/NZD exchange rate, it would be prudent to
take out a forward exchange contract (FEC) as the amount and timing of the transfer of the
profits back to Australia are reasonably certain.
The following steps outline a recommended approach for successfully completing the tasks.
Task 1
Step 1 – Identify the two main alternative markets to choose from
1. Finance the working capital through facilities in Australia.
2. Finance the working capital through facilities in New Zealand.
Step 2 – Use your understanding of a natural hedge to choose the appropriate

market
The working capital should be financed in the New Zealand market.
Exchange rate risk (see CSG content) is the risk that the rate of exchange used to convert foreign
currency to the home currency will move in a direction that causes profitability and/or net
shareholder wealth to decline. Exchange rate risk is considered the key risk in this situation.
If the working capital is raised in Australia, exchange rate risk will arise when transferring the
funds to NZ and back again for repayment.
The group treasurer can avoid this exchange rate risk by financing the working capital in
New Zealand through a short-term loan facility with a New Zealand bank. On this basis, the
funds to finance the working capital, the finance costs, the expenditure incurred to complete
the project, and revenue received throughout would all be in the same currency, thus forming a
natural hedge. The working capital, therefore, should be financed in the New Zealand market.

ACT
Task 2
Step 1 – Identify the financial risks inherent in the contract
Having reviewed the contract, you have identified credit and interest rate risks.
Step 2 – Assess the risks identified and recommend the appropriate treatment
Credit risk is the risk that the other party to a financial transaction will not meet its obligations
on time, or at all. KDY will have policies and procedures in place regarding the evaluation and
acceptance of debtors.
In this case, the debtor is the New Zealand Government, and in compliance with internal
procedures, the credit rating would have been checked and noted. The credit rating of the
New Zealand Government is very solid, so the credit risk for this contract is very low.
Recommendation
Given that this risk would be ranked very low due to the credit rating of the New Zealand
Government, the recommended appropriate treatment would be to accept the risk.
Interest rate risk is the risk that movements in interest rates will affect an organisation’s profit
due to an increase in interest expense.
Using short-term financing facilities will give rise to interest rate risk for the duration of the
facility, which in this case is 18 months. The group treasurer will need to assess forecasts for
interest rate movements in New Zealand over the next 18 months. Note that the scenario states
that the interest rate environment is uncertain.
For rising interest rates the group treasurer has two risk treatment alternatives available:
1. Lock the facilities into a fixed rate of interest as part of the facility negotiations.
From an administrative point of view this would be the easiest risk treatment, as the
amount payable is certain and minimal management time would be required during the
period of the loan. However, examination of all alternatives may indicate that it would
be cheaper to enter into a variable rate loan and use a hedging strategy, particularly in an
uncertain interest rate environment. Locking into a fixed rate would preclude KDY from
any upside.
2. Hedge the risk using an appropriate derivative tool.
Step 3 – Identify possible derivative tools to use in this scenario after reviewing
the CSG content
Possible tools are explained in the table below:
Possible derivative tools
Derivative tools Implications for KDY
Interest rate swaps This derivative tool is used to hedge long-term interest rate risks, and so is not suitable
for an 18-month loan
Forward rate Forward rate agreements can be tailor-made to KDY’s exact requirements. This is
agreements the most appropriate derivative tool should the group treasurer need to lock in the
interest rate for the period

ACT
Unit 3: Analysing operations
Activity 3.1
Outsourcing transactional finance activities
Introduction
As a management accountant you may be required to help make decisions within a company
about whether or not to outsource certain activities.
For this activity you are required to assess the viability of a company outsourcing a function.
• Apply appropriate decision models to short-term decisions such as outsourcing, product
line development, product mix and supply chain analysis.
At the end of this activity you will be able to apply the decision-making processes involved
in assessing whether or not to outsource certain activities.
Scenario
Following the value chain review undertaken earlier in the year, SDT’s chief financial officer,
Charlene O’Shay, has been contemplating outsourcing SDT’s transactional finance activities
(accounts payable, accounts receivable and payroll processing). She suspects that processing
them internally is not adding value to the company. Charlene believes that staff supervision
time would be replaced by time required to manage outsourced relationships.
Charlene has approached you, the management accountant, for advice on this issue. Assume
SDT can borrow at 9%.
Tasks
For this activity you are required to do the following:
1. Describe the two decision-making models available to guide the decision on whether
to outsource SDT’s transactional finance activities.
2. Determine the most appropriate model to use for evaluating this decision. Justify
your selection.
3. Determine which aspects of SDT’s transactional finance activities should be outsourced.
Show all calculations.
maaf12103_act_01

ACT
Spreadsheet
Note: In order to complete Task 3, you have been supplied with additional information
and an answer template in an Excel spreadsheet [Activity 3.1.xls] containing the following
worksheets:
• HO Costs & Staff (background)
• Accounts Payable (background)
• Accounts Receivable (background)
• Payroll (background)
• Answer template.
Please access the learning materials for Unit 3 in myLearning to access the spreadsheet.

ACT
Solution
1. The two models available to guide the decision were the relevant and differential cost model
and the opportunity cost model.
2. The right model to use for analysing whether to outsource SDT’s transactional finance
activities is the relevant and differential cost model because the activities are cost-based.
3. Based on the financial evaluation undertaken, and depending on the assessment of
qualitative factors, the decision would be to retain the accounts payable and accounts
receivable activities in-house, and to outsource the payroll transactional activity. This would
lead to annual cost savings of $55,638.94.
Following is a recommended approach for successfully completing the tasks.
Task 1
There are two decision-making models that are relevant to outsource (make-or-buy) decisions.
These are explained in the CSG content.
1. Relevant and differential cost model

This model identifies the future costs that would eventuate under an in-house (‘make’) scenario
and an outsource (‘buy’) scenario.
If SDT ceased processing transactional finance activities in-house by outsourcing them, it can
then identify both relevant existing costs that would no longer be incurred and relevant costs
that would commence.
2. Opportunity cost model

This model looks at the contribution to profitability that is forgone by not using a limited
resource in its next best alternative use.
The resources used in the transactional finance activities do not have an alternative use within
SDT to improve revenue or profitability.
Task 2
SDT should adopt the relevant and differential cost model for the following reasons:
• SDT’s transactional finance activities are a cost-based service and they do not seek to
generate any revenues to recover these costs. This means SDT does not need to consider any
revenue impact models. For example, if payroll was outsourced, SDT could not reasonably
expect to retrain its payroll officers as IT specialists to be charged out to customers. Rather,
the payroll staff cost savings would be offset against the outsource cost.
• SDT can identify the relevant costs of specific transactional finance activities on a process-
by-process basis. By knowing the costs of relevant transactional finance processes, SDT
can get outsource suppliers to quote their costs at this level to provide a comparison.

ACT
Task 3
The steps you would follow to make the outsourcing decision can be summarised as follows:
Step 1 – Identify and agree on the problem

The problem is that SDT’s undertaking of transactional finance activities internally may not
be adding value to the company from a customer perspective. This was identified through the
value chain review undertaken earlier in the year.
At this stage, information is gathered so that the problem can be properly understood.
Financial data is part of the information gathered. Financial data is extracted and analysed
to determine the costs of each activity, such as invoicing and accounts receivable processing,
accounts payable processing and payroll processing.
Step 2 – Identify what the ideal solution would be and the criteria by which this
would be measured
The ideal solution is to have the transactional finance activities undertaken in the most cost-
effective manner possible. ‘Cost-effective’ means delivering to the desired standard and
timeliness at the best possible price. This would be measured by comparing the cost and quality
of internal processing against the cost and quality of outsourcing.
Quantitative and qualitative criteria would include:
• Minimising the cost of transactional finance activities.
• Meeting desired service levels for transactional finance activities, such as accurate and
on‑time payment of bills and staff, and a decrease in average debtor days outstanding.
• No loss of customers.
• No supplier complaints or problems with contract supply.
• No payroll issues causing employee dissatisfaction.
• No loss of strategic and tactical knowledge/intellectual property.
• No new risk introduced – that is, SDT not be exposed to risk for services that
it cannot control.
Step 3 – Generate possible alternative solutions

A brainstorming session is undertaken listing all the possible alternative solutions. The broader
the list the better, as sometimes ‘left-field’ alternatives provide the best solution or become part
of the best solution.
At a broad level, the alternatives encompass the following:
• retain all transactional finance activities in-house
• outsource some activities and retain some activities in-house
• outsource some activities, stop some processes of no value, and retain some activities
in-house
• retain no activities in-house, stop some processes of no value, and outsource the rest
• outsource all transactional finance activities.

ACT
Step 4 – Make a decision based on the evaluation

Apply the data from the case study and the additional information provided to the
relevant and differential cost model, and compare the cost of in-house activity to the cost of
outsourced activity.
SDT transactional finance activities
In-house Outsource cost Difference/comments

current costs
Supervision by Charlene O’Shay
Salary and superannuation $164,250.00 $164,250.00
Employment on-costs $23,405.63 $23,405.63
% of time 40% 40% (refer Excel spreadsheet for details)
Total cost $75,062.25 $75,062.25
Accounts payable
Invoices/month 300 300
Invoices/year 3,600 3,600
Outsource unit cost $25.00 Per invoice
Outsource ‘per invoice’ cost $90,000.00 Total invoice charge p.a.
Outsource supplier set-up $2,000.00 50 @ $40
Salary and superannuation $82,125.00 Risk of gap for urgent payment and
queries
Employment on-costs $11,702.81
Number of FTE* 1.5
Total cost $93,827.81 $92,000.00 $1,827.81
Cost per FTE $62,551.87
Cost per invoice $26.06 $25.56
1
* FTE = full time equivalent employee. An FTE is a person who is employed 37 2 hours per week.

ACT
SDT transactional finance activities
In-house Outsource cost Difference/comments

current costs
Accounts receivable
Invoices/month 250 250
Invoices/year 3,000 3,000
Outsource unit cost $30.00
Total outsource invoice cost $90,000.00
Outsource customer set-up $4,000.00 100 @ $40
Outsource customer follow-up $9,600.00 240 @ $40
Salary and superannuation $109,500.00 Risk of gap to resolve debtor queries
Number of FTE 2.0
Total cost $125,103.75 $103,600.00 $21,503.75
Cost per invoice $41.70 $34.53
Payroll
Operational staff (at 31/12/2018) 139 139
Head office staff 16 14 Reduced by 2 payroll staff
Staff × 26 pay periods 4,030 3,978
Payroll processing unit cost $59,670.00 Per person per pay @ $15
Setting up new staff $2,100.00 42* @ $50 (30% turnover on chargeable

staff )
Terminating staff who leave $4,200.00 42* @ $100 (30% turnover on

chargeable staff )
Annual earnings statements $9,750.00 195 (139 + 14 + 42*) @ $50
Salary and superannuation $114,975.00
Number of FTE 1.5
Total cost $131,358.94 $75,720.00 $55,638.94
Cost per employee per pay $32.60 $19.03
Grand total $425,352.75 $346,382.25 $78,970.50
*42 = 139 × 30% staff turnover

ACT
Step 5 – Outline the qualitative issues that also need to be considered

CFO time
Charlene believes that staff supervision time would be replaced by time required to manage
outsourced relationships. This means that there is no expected saving in her cost.
Accounts payable
Costs are very close ($1,827.81 or 1.9% difference), and given the need to now find resources
for manual payments and queries, the analysis favours retaining accounts payable in-house.
The importance of closely managing constructive supplier contact also favours retaining the
function in-house.
Accounts receivable
Even though there is a reasonable saving of $21,503.75 ($7.17 per invoice or 17.2%) if accounts
receivable is outsourced, this needs to be balanced against customer service considerations.
Effective management of customer relationships is a core competency of SDT.
The risk of customers being handled poorly by an external party may outweigh the benefit of
cost savings, leading to a decision to keep the function in-house.
Payroll
Costs are 42.4% less if outsourced. This suggests there may be an opportunity to make
significant cost savings if payroll was outsourced. SDT would need to weigh up the quality
of service and impact on employees, but the cost savings indicate that further investigation
is warranted. Due to sensitivity, SDT would not outsource liaison with the Department of
Immigration on special work visas, so any analysis needs to allow for this cost.
Overall
Note that some costs will not be eliminated – e.g. vacant desk space. These costs may or may not
have an alternative use. In addition, new activities are necessarily introduced with outsourcing,
namely the management of the outsource arrangement, new processes to deal with queries from
current users of the services, and procedures on resolving errors that may arise.

ACT
Unit 4: Performance measures: KPIs and

balanced scorecards
Activity 4.1
Developing KPIs
Introduction
In this activity you will learn how to develop KPIs.
• Outline a framework for an appropriate performance evaluation system.
• Develop appropriate key performance indicators.
At the end of this activity you will be able to develop KPIs.

Scenario
You are a management accountant at Noir Insurance (Noir ). Noir is a travel insurance company
that sells policies via two channels – through its website and through telephone agents in a call
centre.
Noir’s website
The website is now the most cost-effective way to sell policies and is seen as the long-term
future of the business. Noir has invested in improving its website and its content ticks all the
right boxes that has enabled it to rise up the search rankings. A key goal for Noir is to grow its
online travel insurance sales, this will be achieved as follows:
• Utilise search engine optimisation (SEO) metrics, which are freely available via Google
Analytics. An important key-word used in search engines is ‘travel insurance’, Noir’s
website ranks well using this key-word.
• Improve its SEO: Noir aims to attract customers via search engine results pages (SERPs)
without paying Google or Bing to rank well and be found.
• Once people have landed from a SERP onto Noir’s website, the aim is to keep them in the
website and convert them into a sale: firstly by requesting a quote, and then for the quote to
be accepted and an insurance policy issued and paid for.
Established criteria are used to determine whether a traveller fits Noir’s risk profile, and then a
premium quote for the policy is automatically calculated based on the information input by the
traveller. Noir encourages online bookings by offering a 5% discount on policies booked via its
website. A higher discount rate is available to past policyholders who haven’t made a claim by
providing them with a promotion code, this is done to increase the number of customers who
come back for repeat business.
A visitor to the website can accept a quote and purchase travel insurance by completing some
personal details and making payment using a debit card, credit card or Paypal. Once payment
has been processed the travel insurance policy is issued.
maaf12104_act_01

ACT
Call centre
A secondary goal for Noir is to maintain the current level of policies that are sold via the call
centre, which sells approximately 25% of the policies issued, although, as a proportion of total
policies sold, this is steadily decreasing.
Call centre sales staff obtain a premium quote for the client by entering details into Noir’s
computer system. Sales staff can apply some discretion over the premium amount as the
system allows them to override the computerised premium calculation when they believe it is
appropriate, within specified limits. Call centre staff earn a commission of 5% of the premium
of every policy they sell. The number of staff working in the call centre has decreased in recent
times, leading to issues with staff morale (reflected in high absenteeism) and customer service.
There has been a growing number of complaints that calls have been answered only after long
waits, or are not answered at all. Accepted practice in the industry is to have all calls answered
within 5 minutes. A critical success factor for the call centre is that calls are answered promptly
and a high proportion of callers are converted into issued insurance policies.
Tasks
For this activity you are required to complete the following tasks:
1. Develop four (4) KPIs that management could use to measure the successful growth of
travel insurance sales via its website. Explain how each of these indicators measures a goal,
objective or factor critical to Noir successfully achieving its goal to grow its travel insurance
sales via its website.
2. Develop four (4) KPIs that the call centre manager could use to measure the operational
performance of the call centre staff. Justify each KPI.

ACT
Solution
Task 1
KPI Explanation of how KPI links to goal of growing travel insurance
sales via website
Organic traffic: number of visitors It is critical to attract customers to the website in order to grow website
from Google / Bing, measured daily sales. Organic traffic measures the traffic earned from appearing in the
SERPs without paying for placement, hence is a good measure as Noir
aims to attract customers without paying Google or Bing
Organic bounce rate, measured The organic bounce rate measures the percentage of visitors that left
daily Noir’s website after only viewing one page. This is a useful measure as it is
Noir’s aim to retain visitors within the website
Percentage of retained visitors that Noir’s aim is to get visitors in their website to request a quote. The more
requested quotes, per week quotes, the more likely Noir is to grow website sales
Percentage of quotes converted to A quote on its own is of little value to Noir, it is critical that quotes get
policies per month converted into policies sold
Number of policies using past Website sales can be increased by selling to customers that have
traveller promotional code per purchased travel insurance from Noir in the past. This KPI will measure the
month number of returning customers
Number of travel insurance policies Policy sales link to premium revenue. The greater the number of policies
sold per month sold, the greater the expected level of premium revenue
Total premiums (revenue) per Revenue is a direct measure of financial success and current growth
month
Notes:
The above does not include all possible KPIs that would be marked as correct. Bear in mind that only four KPIs should be
provided, if there are more than this in a solution to an exam, then just the first four would be marked. More than four
KPIs have been provided in this solution to illustrate the variety of answers that would be accepted.
Whilst it is acceptable to have a KPI expressed as a percentage, it should not be expressed as a percentage change. This is
because a KPI should be a stand-alone or absolute value it order to facilitate analysis.
Task 2
Examples of acceptable KPIs that could be used Justification
to measure operational performance of call
centre staff
Number of unanswered calls per hour (measured Unanswered calls would result in lost potential business.
daily) Having this information available will enable quick action
to be taken to ensure that all calls get answered
Number of calls taken more than 5 minutes to Acceptable practice in the industry is to have calls
answer, measured daily answered within 5 minutes. Hence this KPI will enable
action to be taken if callers are waiting for more than 5
minutes
Call conversion rate per day Converting calls into issued insurance policies is a critical
(i.e. percentage of calls converted into policy sales) success factor
Average discount per policy for each staff member As sales staff have some discretion over the premium
in the call centre, measured weekly amount and this impacts directly on profitability, it
would be prudent to monitor the level of discount each
member of staff allows to ensure that it is being applied
appropriately and consistently by call centre staff
Number of hours lost to absenteeism per month This would measure the level of staff morale which would
need to be improved
Number of calls received per call centre staff Aim would be to ensure that there are enough people to
member, measured weekly answer calls

ACT
Task 1
The steps outline the recommended approach for successfully completing Task 1.
Step 1 – Identify objectives/success factors that will enable the growth of the
website
It is important that these are based on facts in the background information, and could include:
• Effective search engine optimisation (SEO).
• Organic growth of traffic from SERPs.
• A website that is easy to use and navigate to relevant information, retaining visitors in the
website with the aim that they request a quote.
• Ability to analyse risk level associated with each quotation request, and provide a quote
based on key risk factors.
• Provision of quotes that are cost competitive so that a high proportion of customers that
request quotes accept them and purchase travel insurance. .
• User-friendly process for potential customers to obtain quotes, and then convert these
into policies.
Step 2 – Develop a series of KPIs, linked to business objectives or key drivers

of success
• Refer to the suggested solution.
Step 3 – Ensure that your KPIs are appropriate (see CSG content)
Ask yourself questions such as:
• Does the KPI link to the key drivers of organisational success, OR does the KPI link to
organisational goals/objectives that are included in the scenario? Generic KPIs should not be
used.
• Is the KPI clearly articulated to ensure that it is interpreted consistently?
• Will the KPI effectively measure whether the success factor or goals/objectives have been
achieved?
• Will the KPI generate the intended actions that will lead to the achievement of the success
factor or goal/objective?
• Where will the information for this measure come from? Certain measures can be provided
directly from an organisation’s internal systems or via internet tools, such as Google
Analytics in this case.
• How often should this measure be reported?
Task 2
The steps outline the recommended approach for successfully completing Task 2 would be
similar to those for Task 1.

ACT
Activity 4.2
Linking the balanced scorecard to an
organisation’s strategy
Introduction
In this activity you will develop a balanced scorecard and strategy map, including KPIs,
for a retail business. You will also assess the impact of different forms of remuneration and
performance measures on employee motivation.
• Develop and apply the balanced scorecard performance management model.
At the end of the activity you will be able to develop a balanced scorecard for an organisation,
showing the links to the organisation’s strategy.
Scenario
You are the management accountant at Leading Organics (LO) reporting to the CFO, Mark Newson.
LO is a company listed on the Australian Securities Exchange. LO has eight stores across
Victoria, with its flagship store situated in central Melbourne. Its stores stock organic food,
as well as organic cosmetics and beauty products.
LO’s strategy is to be the leading retailer of organic non-perishable food (for example nuts,
seeds, lentils and rice) and beauty products in Victoria. The LO board has given the directive
that no new stores should be opened, however the utilisation of existing store space should be
improved, and current margins should be maintained.
The company has a reputation for stocking the best quality and range of products. Careful
consideration is given at a senior management level to the product lines and brands stocked,
to ensure that the company’s reputation is maintained.
The following information is provided to assist you with completing the tasks below.
Product range
LO stocks an extensive range of many well-known organic beauty products, it also stocks
a number of lines under exclusive agreements with suppliers, ensuring it is the sole local
retailer. As a result, approximately 30% of product stocked by LO is not available anywhere
else in Victoria. LO head office employs a highly skilled buyer to manage its stock lines and
to determine customer pricing. Although the company does stock a number of local food and
beauty product lines, the majority of this stock is imported. LO aims to source 60% of its food
supplies as well as 30% of its beauty products from Victoria by 20XX.

ACT
Purchasing
A key area of focus for the board relates to the purchasing of stock. Depending on the nature
of the product, lead times between placing a non-cancellable order and receiving the stock can
be significant. For example, beauty products often need to be ordered three months in advance.
LO plans to purchase either Power BI or Tableau data analytics software and you and your
assistant are to be trained up in the use of the software. The aim would be to better predict
customer purchasing patterns so as to reduce stock-outs as well as excess stock levels.
In-store experience
Similarly, the in-store experience of customers is considered pivotal for LO, particularly in light
of the increasing popularity of online retailers. Sales staff are trained to provide a personalised
shopping experience for each customer. Many of the sales staff have developed good
relationships with their customers many of whom purchase all their non-perishably food and
beauty products from LO. The ambience and layout of the stores is seen as critical to attracting
new customers and retaining existing customers. LO has done some data analytics and found
that if a customer purchases the same product on more than one occasion, then there is a 70%
likelihood that they will buy the product on a regular basis. High-value existing customers are
issued with a LO gold card and their purchases are recorded in a customer database. All other
customers are offered a bronze privileges card, if they do not show a card at time of purchasing.
Store manager responsibilities

Each of the eight stores is run by an experienced store manager. They are responsible for
the store opening hours, store layout and design display, resupply of stock from the central
warehouse, staff management and the customer experience while in the store.
Tasks
1. Develop a balanced scorecard for LO at the organisation level by:
(a) Identifying LO’s strategic objectives and the perspective they correspond to.
(b) Identifying any linkages between the objectives by creating a strategy map.
(c) Developing a measure in the form of a KPI for each objective.
2. (a) Develop two (2) new KPIs which would be appropriate to include in the internal process
perspective of a balanced scorecard for the individual stores.
(b) For each KPI explain how it links back to LO’s strategy.

ACT
Solution
Task 1
The solutions to (a) and (c) of the task are outlined in the following balanced scorecard.
The strategy map (solution to (b)) lies below these.
Financial perspective
(a) Objective (c) KPI Comments
Maintain existing margins Gross margin per month Monitoring gross margin regularly
throughout the year will enable it to be maintained
Improve utilisation of existing store Revenue per square meter, Increasing revenue generated per
space by X% by the end of the year measured monthly square meter will ensure that the
utilisation of existing store space
is improved
Customer perspective
New customers signed up per year Number of bronze privileges cards New cards are offered if the
issued per month customer isn’t listed in the
database as a previous customer, to
identify new customers and ensure
this KPI is measurable
Retention of X% of existing Percentage of existing privileges It is important to understand

customers per year card holders making repeat whether customers return and at
purchases, measured monthly what frequency
Internal process perspective
Source 60% of food and 30% of Percentage of food supplies Monitoring the level of purchases
beauty products from Victoria sourced from Victoria, measured from Victoria will enable the buyer
by 20XX monthly to work on achieving the targets
Percentage of beauty products
sourced from Victoria, measured
monthly
Ensure product range meets Customer rating of completeness of This directly measures whether
customer requirements, per quarter product range, measured quarterly customers are satisfied with the
product range
Learning and growth perspective
Improve data analytics capability Percentage completion of project Installation of analytics software
by installing Power BI or Tableau by to install software, measured will improve LO’s capability to
the end of the year weekly predict customer needs
Train management accountant Hours of analytics software training It is essential to have well trained
and assistant to effectively run the completed, measured monthly staff in order to effectively run the
analytics software by X date analytics software
Note: The above KPIs are a sample of what would be considered to be appropriate for LO.
A number of other KPIs may be equally appropriate.

ACT
(b) Strategy map:
Improve utilisation
of floor space Maintain margins
Retain customers New customers
Enhance product
range and reduce Effective
stock-outs and purchasing of stock
excess stock
Implement data Upskill management

analytics software accountant in use of
analytics software

ACT
Task 2
(a) KPIs Comments (b) Link to LO’s strategy
Number of sales staff per store This is a customer management Efficiency and responsiveness
per month process and is within the control of of sales staff – links to return to
store management shareholders and customer service
Number of customers returning to Customers who purchase the same Effectiveness of sales staff – links to
purchase the same item, measured product a second time are likely to return to shareholders
weekly purchase the item regularly
Number of stock-outs per month If inventory is not available for the Part of making shopping
customer to purchase, this is likely convenient for the customer. LO
to result in lost sales and lead to needs to ensure it maintains items
customers going to a competitor that customers are seeking in stock
Recommended Approach
The steps outline the recommended approach for successfully completing Task 2.
Step 1 – Review the key perspectives of a store against the operational

drivers of success for LO as a whole to determine their different roles and
responsibilities
Step 2 – Determine the key internal processes that are likely to occur within a LO
store, given roles and responsibilities of the manager
Examples of this would include:
• Access to inventory to ensure stock is available for purchase when required.
• In-store displays.
• Level of service provided to customers.
Step 3 – Develop two KPIs that you consider appropriate for the store
Examples of possible KPIs include:
• Number of sales staff per store per month.
• Percentage of customers purchasing more than one item in a single transaction per month.
• Number of stock-outs per month.
Step 4 – Ensure that your KPIs are appropriate

See CSG content on ‘Developing appropriate KPIs’.
Step 5 – Define the link between your KPIs and how they support the
organisational strategy of LO
Refer to the suggested solution above.

ACT
Activity 4.3
Balanced scorecard – not-for-profit entity
Introduction
This activity uses the balanced scorecard framework in the not-for-profit environment, where
the primary objective is assisting the needy, rather than maximising the return to shareholders.
It links to unit learning objective:
At the end of this activity, you will be able to develop a balanced scorecard for a not-for-profit
entity.
Scenario
The Food Spirit Foundation (Food Spirit) is a not-for-profit organisation whose vision (mission)
is to ‘improve the quality of life of the homeless by providing a hot meal and counselling and
support to people without accommodation who live on the streets of Sydney’.
Food Spirit operates a number of food vans in the inner city every night of the week. Meals
are cooked at premises in an inner-city suburb by a team of volunteers. Another group of
volunteers drives the vans and delivers the meals to people in need. These volunteers have had
training to also provide counselling and support to those who need it. Where appropriate, they
will direct people using the food vans to other organisations that provide different services;
for example, temporary accommodation or medical care. Many of the people using the meals
service are keen to have someone to talk to while enjoying what is often their main meal of
the day.
The volunteers are primarily university students who have flexible routines, which enable them
to work in the kitchen in the afternoon or on the vans in the evening. Unfortunately, once these
students finish their studies, many of them find it difficult to juggle this volunteer work with
their careers. As a result, new volunteers constantly need to be sourced and trained.
Most of the ingredients used in the preparation of meals are donated, often from supermarket
chains, food wholesalers or manufacturers who give products that are nearing the end of their
shelf life. When the provision of essential ingredients is low, these are purchased from financial
donations. The prepared meals are simple but highly nutritious.
Financial donations are critical, as they provide funding for administrative costs to run the
vans, maintain the premises that contains the kitchen and a small office, pay the small number
of employees, and provide training to the volunteers. Food Spirit aims to keep expenditure for
administration (i.e. funds spent outside of meals preparation and delivery) to a minimum, to
maximise the number of people it can assist.
Financial donations are received from both corporate and individual donors, with the bulk
received from the foundation’s annual Christmas appeal. This appeal includes volunteer
collectors who door knock homes and attend major events seeking donations. A number of
media organisations donate advertising space, which Food Spirit uses throughout the year to
appeal for donations.

ACT
With the high turnover of volunteers at Food Spirit, the CEO is keen to use a balanced scorecard
(BSC) to communicate with and align all of the foundation’s stakeholders. They plan to
update the BSC on a quarterly basis and publish it on the website as well as post it on internal
noticeboards and in their vans.
You are a volunteer who is helping to provide accounting advice to Food Spirit, and have been
asked to assist in developing the BSC.
Tasks
1. Develop a BSC for Food Spirit, including two (2) KPIs in each BSC perspective (and within
the customer perspective including each category of customer).
2. Explain how each KPI will help Food Spirit achieve its vision.

ACT
Solution
While a rationale has been provided in the solution, there was no requirement for this in the
task.
Tasks 1 and 2
BSC for Food Spirit
Perspective KPIs (examples) Explanation Rationale
Financial Dollar value of The more donations received The KPIs in the financial
donations received per should equate to more people perspective in a not-for-profit
quarter being assisted scorecard should relate to
Percentage of Minimising the amount spent obtaining funds, and to applying
donations spent on administration means that these effectively and efficiently
on administration more funds can be directed to to achieve the stated objectives.
per quarter providing meals In a not-for-profit environment,
the financial measures are not
the outcome of the business but
rather the input – because of
their scarcity and importance in
delivering the mission (vision),
these measures are critical to the
organisation’s success
Customer Value of donated Advertising space is used to attract Both of these KPIs are outcome-
(donor) advertising space donations that enable Food Spirit focused – how much advertising
received per quarter to provide its services space has been donated, and
Number of The more organisations that how many organisations are
organisations donating donate food, the less likely it is that donating food – both factors are
food items per quarter Food Spirit will need to use cash critical. Community awareness of
funds to buy basic food supplies. donor organisations is important
It also means more food will be for donations to be received, as
available for clients well as awareness of the services
provided by Food Spirit. The
supply of food is critical to the
delivery of meals
Customer Number of meals The number of meals served is These two KPIs are directly linked
(recipient) served per quarter directly linked to how Food Spirit to the two stated objectives – to
is assisting the homeless help the needy by providing a
Number of recipients Providing counselling is another hot meal, and counselling and
referred to other stated objective of Food Spirit, support
support organisations achieved, in part, by providing
per quarter information on other support
services available
Internal Number of meals Food Spirit’s kitchen activities These KPIs are focused on two of
cooked/prepared per directly impact on the number of Food Spirit’s operating processes
quarter homeless people receiving meals – the provision of meals (one
Number of hours Without the collectors, the amount of the key objectives of the
worked by donation donated would be reduced. organisation), and the process of
collectors per quarter The more collectors, the wider the obtaining donations
area the foundation can target,
which should result in additional
funds being donated. This will
be particularly important in the
December quarter and the annual
Christmas appeal

ACT
BSC for Food Spirit
Perspective KPIs (examples) Explanation Rationale
Learning Number of new Food Spirit relies heavily on This perspective measures
and growth volunteers recruited volunteers to provide its services. where the business needs to
per quarter It has a high turnover of them, develop. Attracting volunteers
so attracting new volunteers and training them to deliver the
is essential to the continuing organisation’s services are critical
delivery of meals and other to Food Spirit’s success
services
Number of volunteers A stated objective is to provide
completing counselling and support, therefore
counselling training providing volunteers with these
per quarter skills aligns directly with the
objectives of the organisation
The steps outline the recommended approach for successfully completing the tasks.
Step 1 – Establish Food Spirit Foundation’s key objectives (based on the vision)
Vision
Improve the quality of life for the homeless.
Establish the key objectives for Food Spirit, which include:
• Provide (cook and distribute) hot meals to people without accommodation who live on the
streets of Sydney per day.
• Provide counselling and support to people without accommodation who live on the streets
of Sydney per day.
• Be financially sound enough to enable provision of these services per year.
• Attract donors of financial resources per year.
• Attract volunteers to provide services per quarter.
• Train volunteers to provide services per quarter.
• Obtain donated food from organisations per week.
• Maximise the number of people the foundation can assist per quarter.
• Keep costs down per month/quarter.

ACT
Step 2 – Map objectives within the balanced scorecard framework

Consider the perspectives in the BSC, then map the objectives for Food Spirit into the
perspectives.
BSC perspective Objectives
Financial Be financially sound enough to enable provision of services per year

Attract donors of financial resources per year
Keep costs down per month/quarter
Customer Obtain donated food from organisations per week

Maximise the number of people the foundation can assist per quarter
Internal Provide (cook and distribute) hot meals to people without accommodation
who live on the streets of Sydney per day
Provide counselling and support to people without accommodation who live
on the streets of Sydney per day
Learning and growth Attract volunteers to provide services per quarter

Train volunteers to provide services per quarter
Step 3 – Define appropriate KPIs for Food Spirit Foundation

Now that Food Spirit’s key objectives and the perspectives they relate to have been identified,
the BSC can be drafted. The key areas of difference to a BSC in an entity operating with a profit
focus relate to the requirements of the financial and customer perspectives (see the table above
in the suggested solution).

ACT
Activity 4.4
Remuneration and motivation
Introduction
In this activity you will assess the impact of different forms of remuneration and performance
measures on employee motivation.
• Explain the impact of remuneration packages and performance measurement on behaviour,
motivation and decision-making.
At the end of this activity you will be able to assess the potential impact of remuneration
arrangements on employee behaviours.
Scenario
This activity is based on the scenario for Activity 4.2, to which you should refer to complete
this activity.
You are a management accountant at Leading Organics (LO), reporting to the CFO, Mark Newson.
Mark has asked you to help assess the current remuneration and motivation scheme at LO.
Tasks
1. The LO store managers receive a quarterly bonus based on their respective store’s
performance as reflected by the balanced scorecard measures. Outline why the store
managers might have reservations about this being equitable.
2. Explain the impact on the store managers’ behaviour if they receive their bonuses based
solely on either:
• Their store’s profit.
• Their store’s revenue.
Consider both positive and negative aspects of each of these measures in your response.
3. LO staff receive an hourly wage plus a commission on all sales that they personally make.
Outline two (2) positive and two (2) potentially negative implications of this arrangement.

ACT
Solution
Task 1
The store managers might feel that some of the key drivers in the BSC are outside of their direct
control. For example, profitability of the store will be impacted by the purchase price of the
goods sold and their selling price – both of which are determined by the buyer at head office.
Task 2
Impact on store managers’ behaviour of quarterly bonus based on a store’s performance
Positive impact Negative impact
Store profit They would likely make • They may ignore longer-term drivers such as staff training, as
decisions that would they might consider staff time is better spent on the sales floor
optimise store profitability serving customers (directly driving sales) instead
– for example, not overstaff • Store managers may be demotivated as they cannot control all
store costs – for example, rent is a large expense that is subject
to reviews and increases which they cannot influence
Store They would likely focus They might make short-term decisions that are costly in the
revenue on one of the key drivers long term to reach their targets – for example, being pushy with
of the business. As they customers sale. They might also employ more staff than necessary
cannot affect selling prices, to drive sales, thus harming profitability. The focus on just one
they would be very focused driver is risky for the achievement of LO’s overall corporate strategy
on sales volumes
Task 3
Implications of having an hourly wage and commission arrangement
Positive • Employee sales efforts are directly connected to their remuneration (i.e. increased effort
is rewarded)
• The arrangement clearly rewards sales success (i.e. employees can clearly see how their
effort translates to reward)
Negative • May lead to dysfunctional behaviour (e.g. unhealthy staff competition – staff ‘stealing’
sales from each other, tagging customers as ‘mine’ and fighting over customers – which
would not add value to the customers)
• Without an effective computer system at the point of sale to capture the sales at an
individual salesperson level, it will be difficult to equitably allocate sales and could, in
fact, be demotivating
• Sales staff may be reluctant to attend training or staff meetings as these would take away
from time selling to customers

ACT
Activity 4.5
Performance measurement and evaluation
Introduction
This is an integrated activity that combines the topics of performance analysis, performance
measurement and management, and strategy.
For this activity you are required to evaluate a balanced scorecard, and discuss whether
alternative measures and data provide a better framework to measure an organisation’s
strategy. The final part of the activity requires an explanation of how a bonus structure could
result in employee behaviour that is not in line with an organisation’s vision and strategic goals.
This activity links to the following unit learning objectives:
Unit 1
Unit 4
• Explain the impact of remuneration packages and performance measurement on behaviour,
motivation and decision-making.
Unit 6
• Evaluate financial ratios and trends used to analyse the financial performance of an
organisation.
• Review and analyse draft management reports.
You may wish to read the relevant sections of Unit 6 before completing this activity.
It will take you approximately 45 minutes to complete this activity.
Scenario
Environment Cantago (EC) is a New Zealand environmental agency, whose vision is ‘to make
Cantago the cleanest, most unpolluted region in New Zealand’. Its strategic goals (for the
three‑year period) were as follows:
• Reduce the level of environmental damage on dairy farms caused by chemicals and waste
products generated by dairy farmers by 15%.
• Restore half of the currently degraded land.
• Increase the number of farms using sustainable farming methods by 20%.
The Cantago region has over 200,000 hectares of farmland, most of which is owned by 1,800
large-scale dairy farms. While dairy farming has boosted the economy of the region, significant
concerns have been raised regarding the negative impact that the industry is having on the
region’s environment.

ACT
About 25,000 hectares of farmland in the Cantago region is degraded or polluted and in need of
restoration. Farmers in the region are motivated to restore degraded land, and many would like
to introduce sustainable farming methods; however, they lack the technical expertise in both
these areas.
EC has two divisions. The inspections division inspects farms, identifies breaches of
environmental laws and prosecutes these breaches. The environmental consulting division
provides advice to farmers on how to restore degraded land and introduce sustainable
farming methods.
EC’s key stakeholders are residents of the region (the majority of whom are not dairy farmers),
environmental activist groups, as well as the central government that provides most of
EC’s income.
EC’s critical success factors are as follows:
• Identification of breaches of environmental laws by dairy farmers.
• Successful prosecution of identified breaches of environmental laws.
• Identification of degraded land, diagnosing the causes of degradation, and developing land
restoration plans.
• Development and running of training courses on sustainable farming methods.
The following is EC’s balanced scorecard, which it has used for the last three years:
Perspective Objectives Key performance indicators (KPIs)
Financial Maintain financial efficiency Operating surplus

Percentage change in cash generated from
operations
Customer Improve EC’s relationship with dairy Percentage positive feedback from dairy farmers
farmers
Internal process Increased quantity of inspections Total number of on-site inspections (reported
on a cumulative basis)
Restore degraded land Hours spent working on land restoration plans
Learning and growth Improved staff ability to diagnose Average staff development days per employee
causes of land degradation and
develop land restoration plans
Actual results for EC for Year 3 are as follows:
KPI Year 3 Target
Operating surplus (as a percentage of revenue) 10% 9%
Percentage change in cash generated from operations 7% 5%
Percentage of farmers’ feedback that is positive 75% 70%
Number of on-site inspections 828 800
Hours spend working on land restoration plans 1,243 1,100
Staff development days 533 495
EC’s bonus structure is based on ‘number of targets achieved’. Consequently, EC’s chief
executive officer (CEO) has made the following announcement in relation to the above
actual results:
I would like to congratulate all member of staff for their hard work and commitment in achieving all
our targets. As a result of this achievement, all EC employees will be paid a bonus.

ACT
The Green Alliance, an environmental activist group, has sent an email to EC’s CEO stating that
while EC has a laudable vision and strategic goals, as well as relevant critical success factors, in
Year 3 it has failed to achieve its vision and strategic goals for the following reasons:
• EC’s balanced scorecard is fundamentally flawed.
• The following measures and data generated from research undertaken by the University of
Cantago contradict EC’s actual results for Year 3:
University of Cantago – research data
Cantago region’s dairy farms’ environmental performance Year 1 Year 2 Year 3

(all are measured annually)
Number of recorded breaches of environmental laws 57 65 104
Percentage of dairy farms using sustainable farming methods 6% 7% 7%
Number of farmers successfully prosecuted for breaching environmental laws 3 1 2
Hectares of previously polluted land that has been restored 126 238 645
Number of farms for which ED has developed land restoration plans 7 12 35
Percentage of soil tests indicating high levels of chemicals/waste 16% 21% 22%
Tasks
1. Evaluate EC’s current balanced scorecard in terms of its effectiveness in measuring whether
EC has achieved its vision and strategic goals.
2. Identify linkages between EC’s strategic goals/critical success factors and the measures used
by the University of Cantago. Use the university’s measures to evaluate the performance
of EC.
3. Explain how the current bonus structure could result in actions that are not in line with EC’s
vision and strategic goals.

ACT
Solution
Task 1
Evaluate EC’s current balanced scorecard in terms of its effectiveness in measuring whether EC
has achieved its vision and strategic goals.
General points
• The key performance indicators (KPIs) and related objectives in the balanced scorecard do
not link closely enough to EC’s vision (see the details listed in relation to each perspective
below). It is therefore doubtful that achieving the current targets would be a clear indicator
of whether EC has achieved its vision.
• The balanced scorecard does not incorporate EC’s strategic goals. For example, it is unclear
how the strategic goal to ‘Reduce the level of environmental damage on dairy farms (caused
by chemicals and waste products) by 15%’ is incorporated into the balanced scorecard.
• The critical success factors have not been incorporated into the balanced scorecard. For
example if the critical success factor of ‘Successful prosecution of identified breaches of
environmental laws by dairy farmers’ is not included in the balanced scorecard, then it
could lead to lack of focus on achieving this, which would then mean that the first strategic
goal may not be achieved. If an organisation does not achieve its critical success factors,
it is unlikely that it will achieve its vision and strategic goals.
• The objectives/KPIs are not time-bound. Goals/objectives should be measured over a
specific period of time, so it is important for the time period to be clearly defined to allow
for analysis of the results.
Financial perspective
• The objective ‘Maintain financial efficiency’ is not specific. No clarity is provided regarding
what ‘financial efficiency’ looks like – therefore, it will not be clear whether or not this goal
has been achieved.
• The KPI ‘Percentage change in cash generated from operations’ is a trend that does not
effectively measure whether EC is achieving its objective of maintaining financial efficiency.
Customer perspective
• As EC does not have customers in the manner that businesses do, it needs to look to its
stakeholders to determine who its customers are. The objective ‘Improve EC’s relationship
with farmers’ in the customer perspective does not take into account all key stakeholders,
the majority of whom are not farmers.
• The customer perspective objective to ‘improve EC’s relationship with dairy farmers’ may
be relevant to the environmental consulting division. However a different objective would
be needed for the inspections division.

ACT

• It is questionable whether the existing internal process objective ‘Increased quantity
of inspections’ would have an impact on the achievement of any of the strategic goals.
This is because the emphasis would be placed on increasing the volume of inspections,
rather than on achieving the first two critical success factors which are to identify and
prosecute breaches of environmental laws.
• In relation to the KPI ‘Number of on-site inspections (reported on a cumulative basis)’,
KPIs should not be reported on a cumulative basis as this will mean that the result for
each period is not comparable.
• ‘Total number of on-site inspections’ measures an activity – it does not measure whether
the activity contributes to achieving the organisation’s vision and strategic goals.
• Similar to the previous point, ‘Hours spent working on land restoration plans’ might
be high but there is no guarantee that this would ensure that the critical success factor
‘Identification of degraded land, diagnosing the causes of degradation, and developing land
restoration plans’ is achieved. It effectively measures an input rather than an output.
Learning and growth perspective

• The objective for this perspective is good as it is linked to a critical success factor.
• The KPI ‘Average staff development days per employees’ is not specific to the objective
for this perspective. The KPI should specify the type of staff development that is
required in order to achieve the objective. The KPI should also include a time period
for its achievement.
Task 2
Identify linkages between EC’s strategic goals/critical success factors and the measures used
by the University of Cantago. Use the university’s measures to evaluate the performance of EC.
The following measures from the University of Cantago link to EC’s strategic objectives
and critical success factors, and are therefore a better representation of EC’s vision and
strategic goals:
EC’s strategic goals/ University of Cantago Evaluation of EC’s performance

critical success factors measure
Reduce the level of Percentage of soil tests The results show that the percentage of soil tests
environmental damage indicating high levels of indicating high levels of chemicals/waste has
caused by chemicals chemicals/waste increased from 16% in Year 1 to 22% in Year 3. This
and waste products indicates that EC has not achieved this strategic goal
generated by dairy
farmers by 15%
Restore half of the Hectares of previously Hectares of previously polluted land that has been
currently degraded land polluted land that has been restored is constant and increasing but is a very
restored small proportion of the 25,000 hectares of degraded
or polluted land that is in need of restoration. This
indicates that EC has not achieved this strategic goal
Increase the number of Percentage of dairy farms The percentage of dairy farms using sustainable
farms using sustainable using sustainable farming farming methods has increased from 6% to 7% over
farming methods methods the three-year period – i.e. an increase of 8.6%, well
by 20% below the target of 20%
Identification Number of recorded breaches The number of recorded breaches of environmental

of breaches of of environmental laws laws has increased from 57 in Year 1 to 104 in Year
environmental laws by 3, a significant increase. This indicates that EC has
dairy farmers been effective in identifying these breaches

ACT
EC’s strategic goals/ University of Cantago Evaluation of EC’s performance

critical success factors measure
Successful prosecution Number of farmers The results show that the number of successful
of identified breaches of successfully prosecuted for prosecutions is a small proportion of the number
environmental laws breaching environmental of recorded breaches of environmental laws. This
laws indicates that EC has not achieved this critical
success factor
Identification of Number of farms for which There has been a strong increase in the number
degraded land, EC has developed land of land restoration plans developed, as well as
diagnosing the causes restoration plans in the number of hectares of previously polluted
of degradation, and Hectares of previously land that has been restored. This indicates that
developing land polluted land that has been EC has performed well with regard to this critical
restoration plans restored success factor
Development and There is no University of An indirect measure is the percentage of dairy farms
running of training Cantago measure for this using sustainable farming methods. This percentage
courses on sustainable critical success factor has remained relatively consistent – i.e. it does
farming methods not indicate that EC has performed well regarding
this CSF
Task 3
Explain how the current bonus structure, which is based on ‘number of targets achieved’, could
result in actions that are not in line with EC’s vision and strategic goals.
From Task 1, it can be seen that the objectives and KPIs in the balanced scorecard are not linked
to the existing strategic goals of the organisation. This means that employees are motivated to
act in a way that is not in line with EC’s strategic goals. Examples of this are as follows:
• The KPI ‘Average staff development days per employee’ – staff could attend more courses
than is necessary, or attend courses that are not relevant to EC’s vision.
• The KPI ‘Total number of on-site inspections’ – the quantity of inspections could be
increased to achieve this KPI; however, this could result in inspections being rushed.
• The KPI ‘Hours spent working on land restoration plans’ measures an input. Employees
could spend excessive hours working on the plans without being motivated to complete
them. A better KPI would be the number of completed restoration plans.
• The relationship with farmers could be improved by avoiding any prosecutions. This will
ensure that positive feedback from farmers is increased (and that this target is achieved).
However, EC’s goals and critical success factor would not be achieved.

ACT
Unit 5: Performance measures: budgeting

and forecasting systems
Activity 5.1
Limitations of the budgeting process
Introduction
Although budgeting is a useful tool in business planning it does have limitations, particularly
in dynamic and competitive business environments. In such cases, forecasts are often used to
supplement or even replace the budgeting process.
For this activity you are required to assess some of the limitations of the budget process and
understand the difference between a budget and a forecast.
• Outline the business planning and budgeting processes.
• Assess which planning tools are most appropriate to a situation.
Scenario
You are a management accountant at Electric Avenue (EA), reporting to the CFO, Edward Grant.
EA’s background
It is January 20X5. EA is a large retailer of electrical goods and appliances, operating a number
of stores across Australia and New Zealand. Historically, EA has been a star performer in
the retail sector, growing faster than its competitors. Its fast growth has been attributed to
competitive pricing, which the company has been able to deliver due to its buying power and
low-cost store formats.
Economic environment
The Christmas period is normally EA’s strongest sales period; however, this year EA has
suffered its worst Christmas trading period on record. Consumer confidence has been
undermined by some significant corporate failures and an increase in the unemployment rate.
Retailers, including EA, attempted to combat this by commencing their annual clearance sales
earlier than normal.
A major issue is the strong exchange rate of both the Australian and New Zealand dollars
against major currencies (in particular, the US dollar), with consumers increasingly purchasing
online from overseas retailers.
maaf12105_act_01

ACT
Budget process
EA’s financial year is from 1 July to 30 June, with its budget process commencing in
mid‑February. Each of EA’s store managers must submit their store’s draft budget by the end
of March in order for EA’s head office to consolidate and approve them before the beginning
of the new financial year.
Head office provides high-level guidance, including expected sales growth targets and the
anticipated cost price for key product lines. Each store is responsible for developing its full
operating budget (to profit and loss level), and does so knowing that budgeting for a profit
less than its most recent forecast for the current year will not be acceptable to EA head office.
Tasks
Because the retail sector is facing challenging times, Edward has asked you to analyse
the limitations of the current budget process in an attempt to improve its usefulness to
EA management.
You are required to:
1. Identify and explain the key limitations of EA’s annual budget process.
2. Consider EA’s budget process and explain whether it is likely to have been an effective
management control tool to date. Justify your response.
3. Explain how forecasting would address management control deficiencies in the
FY 20X5 budget.

ACT
Solution
This activity involved assessing some of the limitations of the budget process and
understanding the differences between a budget and a forecast.
Task 1
Key limitations of EA’s budget process are as follows:
• Budgets do not necessarily reflect current conditions in the business environment.
Current year performance is used as a base, as managers know that they can’t present
a budget which is less than the current year’s forecast. Therefore, changes in economic
conditions may not be reflected in budget targets.
• Business planning does not appear to link to EA’s strategic objectives. The budget targets
are expressed only in terms of profit growth; are set by head office, and do not reflect
specific conditions affecting individual stores.
• Budgets are submitted at the end of March and approved before the beginning of the new
financial year. This means any emerging changes in the business environment will not be
reflected in budget targets, reducing their effectiveness as a control tool.
Task 2
The budget process is unlikely to have been an effective management control tool given the
significant and unforeseen changes in the market during the period for the following reasons:
• The 20X5 budget was set three to four months prior to the commencement of the financial
year and since that time the market has changed significantly.
• Consumer confidence has significantly declined since the time the 20X5 budget was set.
• There has been growth in consumers’ use of overseas online retailers in this market.
• Strong AUD and NZD exchange rates have improved overseas competitor positions.
Task 3
A forecast is an up-to-date indication of expected financial performance given current and
predicted conditions at a point in time. The implementation of a forecasting process for EA
would allow changes in factors such as exchange rates, the downturn in sales for December
and the move to internet purchasing by consumers to be reflected in the financial estimates.
This would focus management attention so that they could promptly adjust their operating and
strategic plans.

ACT
A recommended approach for successfully completing each task is outlined below:
Task 1
Step 1 – Common limitations of the budget process
There are common limitations to annual budgets as discussed in the CSG content.
Step 2 – Analyse EA’s circumstances

After analysing EA’s situation as described in the background material, identify the issues.
Task 2
Step 1 – Common control tools
The concept of management control tools is discussed in the CSG content.

After reviewing the CSG content and analysing the information provided about EA, you will be
able to see that the budget process is unlikely to have been an effective management control tool
given the significant and unforeseen changes in the market during the period.
Task 3
Step 1 – Advantages of forecasting
Forecasts and their advantages are discussed in the CSG content.

After reviewing the core content, consider how it applies to EA’s circumstances.

ACT
Activity 5.2
Business planning in a not-for-profit context
Introduction
Business planning is an important tool for aligning an organisation’s strategic plans and
objectives with the outputs and financial outcomes of its ongoing operations. As a management
accountant, a solid understanding of the principles of business planning will allow you to assist
businesses, including not-for-profit entities, in implementing a business planning process.
For this activity you are required to demonstrate the interaction between strategy, planning
and budgeting.
• Outline the business planning and budgeting processes.
• Identify and apply the most appropriate budget methodology.
Scenario
You are a management accountant working for B-There Foundation (B-There), a not-for-profit
organisation. You report to the general manager, Maya Patel.
Purpose and vision

B-There operates a community nursing program in regional Queensland. The program supports
families dealing with mental health issues by providing specially trained mental health nurses.
The services are focused not on the family member with the mental health illness, but rather
on the family group, whose needs are often overshadowed by the level of care required for
the patient.
Established only 18 months ago as a pilot program in a limited geographic region, the
community nursing program has proven highly successful and B-There now plans to expand
further into regional Queensland.
Funding and services

As a not-for-profit entity, B-There receives a small amount of government funding but plans
to increase community awareness of its activities and fund expansion by running a number
of local fundraising initiatives. The organisation plans to attract the support of prominent
community members, and hopes to raise enough funds to pay for nurses’ salaries and business
operating costs for the following 12 months. The objective is to have two specially trained
mental health nurses and a supervisor operating in each of the six geographic sub-regions
by the end of the financial year; however, initially the program is likely to start with just one
nurse in each of the regions. The demand for services, along with the available funding, will
determine when additional staff are hired.

ACT
Administration
B-There aims to keep its overheads and administration costs low (to less than 7% of revenue) by
having sub-region nursing staff work from their homes, and most of the fundraising work done
by local community volunteers.
A small administration team is based in a rented office in Mackay (North Queensland).
Tasks
Prior to commencing the development of the operating budget for the upcoming financial year,
Maya Patel has set you the following tasks:
1. Outline how the B-There strategy would be reflected in its operational plans and operating
budget.
2. Identify the most appropriate budget methodology B-There should use to develop its
operating budget. Justify your response.
3. Explain the basis upon which B-There should develop budgets for the new geographic
sub‑regions.

ACT
Solution
For this activity you were required to demonstrate the interaction between strategy, planning
and budgeting.
Task 1
B-There’s strategic plans to expand into new geographic regions would be reflected in the
following ways:
• The phasing of the operating budget would reflect the planned timing of the establishment
of the new sub-region operations.
• The expected demand for services in the new sub-regions would have to be estimated so
that the timing of staff hiring could be reflected (along with their expected salaries).
• Fundraising initiatives should be scoped for the operating plan and then reflected in the
budget (including their timing, the expected costs and estimated receipts raised). These
initiatives would need to be consistent with the timing of staff hiring, as the expansion is
dependent on successful fundraising.
• The administration budget should be straightforward as it can be based on prior year
operations.
Task 2
The most appropriate budget methodology for B-There to employ for the upcoming financial
year would be a combination of the top-down and zero-based methodologies. This is due to the
following factors:
• There would be few people at the operational level with the information and knowledge
necessary to complete the budget (e.g. the supervisors in the sub-regions would not have
the required knowledge, and may not even be hired yet).
• There is a limited organisation history combined with significant growth plans (while
historical performance will provide some guidance, more than incremental growth is being
planned).
• B-There is preparing a budget for a new program and has little historical material on which
to base this budget.
Task 3
Sub-region budgets should be based on the experiences of B-There in the previous 18 months of
establishing its current operations.
This understanding could then be applied to the new regions, with any adjustments for known
local conditions (e.g. variations in economic conditions such as unemployment that might
impact on fundraising). This is similar to a zero-based budget approach.

ACT
The following steps outline a recommended approach for successfully completing each task in
this activity.
Task 1
Step 1 – Define B-There’s strategy
B-There’s strategy has been defined in the scenario. Its strategic objectives for the coming year
are to expand its services into each of the six geographic sub-regions.
Step 2 – Reflect the expansion in the operating plan and budget

Changes in the operations plan and budget will need to be predicted and assessed to reflect the
expansion strategy.
Task 2
Step 1 – Compare the various budgeting methodologies
The CSG content for this unit defines and explains the various budgeting methodologies. These
should be reviewed and consideration given as to which approach best suits B-There.
Step 2 – Analyse B-There’s situation to make a decision

Once the differences between the types of budgeting are understood, the most appropriate
method can be applied to suit B-There’s specific situation.
Task 3
Step 1 – Consider the budget information that would be required for the new
sub-regions
Based on the organisation and what it is trying to achieve, determine the key information
requirements for completing a budget for the sub-regions.
Step 2 – Consider the information that could be gained from reviewing B-There’s
performance over the past 18 months
By examining B-There’s performance over the past 18 months, informed decisions can be
made on how best to proceed with expansion plans, particularly regarding key factors
affecting funding.

ACT
Activity 5.3
Analysing a budget
Introduction
Operational plans are translated into financial plans in the form of budgets and forecasts.
The ability to critically analyse a budget or forecast is essential in determining whether
operational plans are realistic.
For this activity you are required to analyse a budget against a current year forecast to identify
the initiatives reflected in the budget and the key drivers of performance.
• Analyse the key factors, constraints and assumptions in developing a budget or forecast.
Scenario
You are a management accountant working at the head office of Green Coat Group (Green
Coat), a marketing and promotional group that develops innovative ways to connect consumers
to advertisers and their products. The business units that make up the group have submitted
their budgets for 20X4, and you have been asked to review their submissions and provide
feedback to group management.
In completing their budgets, the business units were given the following guidance from head
office:
• Inflation is expected to be 3% for 20X4.
• Salaries and wages will increase by the rate of inflation.
• Market revenue for traditional media advertising (such as print, television and outdoor
signage) is expected to decline, with advertisers moving that expenditure to digital
advertising.
• Given the expected pressure on revenue, business units should look for ways to reduce their
costs so that profitability shows significant improvement on the ‘disappointing’ forecast
for 20X3.
One business unit in the group publishes a free weekly magazine, Spree, targeted at readers
who love to shop. The magazine is distributed to commuters at major transportation hubs in
Brisbane, Sydney and Melbourne each Wednesday afternoon (except for the Christmas/New
Year period). It is a premium product, and advertisers consider it to be an effective marketing
tool. After printing and distribution costs, salaries and wages (editorial and advertising staff)
are the next largest expense of the business unit.

ACT
Spree Magazine’s operating budget submission, completed in Green Coats’ required format,
which includes key operational statistics, is shown below.
Spree Magazine 20X4 budget
20X3 20X4 20X4 v. 20X3
Forecast Budget Variance +/(–) Variance

$’000 $’000 $’000 %
Advertising revenue 18,703 17,588 (1,115) (6.0)
Editorial costs 2,034 2,024 (10) (0.5)
Printing costs 10,098 9,340 (758) (7.5)
Distribution costs 3,114 3,119 5 0.2
Advertising wages 1,502 1,055 (447) (29.8)
Marketing costs 554 500 (54) (9.7)
Administration costs 534 550 16 3.0
Total expenses 17,836 16,588 (1,248) (7.0)
Operating income 867 1,000 133 15.4
Operating margin 4.6% 5.7% 1.1% 22.7
Issues 49 49 0 0.0
Total editorial pages 1,108 1,108 0 0.0
Total advertising pages 856 852 (4) (0.5)
Total pages produced (all issues) 1,964 1,960 (4) (0.2)
Copies printed and distributed (per issue) 1,271,000 1,273,000 2,000 0.2
Key ratios and rates are summarised below:

20X3 20X4
Forecast Budget
Advertising content 43.6% 43.5%
Advertising revenue per page ($) 21,849 20,643
Number of printed pages (million) 2,496 2,495
Printing cost per 1,000 pages ($) 4.05 3.74
Average number of pages per issue 40 40
Distribution cost per copy ($) 0.05 0.05
Editorial cost per editorial page ($) 1,836 1,827
Advertising expense: % advertising revenue 8.0% 6.0%
Task
You have been asked to appraise Spree Magazine’s budget submission, analysing its budgeted
performance for 20X4 compared to the forecast for 20X3. Your observations should be
summarised in a report to Green Coat’s executive management, outlining Spree Magazine’s
operational plans for 20X4 and their anticipated financial implications, while clearly evaluating
the key drivers of the business unit’s financial performance.

ACT
Solution
Analysis of Spree Magazine’s budget submission for 20X4 (compared to the forecast for 20X3) is
as follows:
Overall profitability
Spree Magazine has budgeted to improve profitability by 15.4% ($0.133 million) to $1.0 million,
an operating margin of 5.7%. This is to be driven by significant cost reduction plans
(discussed below) saving $1.248 million, more than offsetting an expected revenue decline of
$1.115 million (6%).
Revenue
Revenue is budgeted to decrease by 6% ($1.115 million) to $17.588 million, primarily due to
advertisers being unwilling to pay the same rate per page (down 5.5% to $20,643) due to the
shift to online advertising. Demand for advertising is budgeted to soften only slightly (4 less
pages or a decrease of 0.5%), as advertisers still consider Spree Magazine to be an effective
advertising tool.
Expenses
The reduction in revenue has not directly led to cost savings (as it has not significantly
decreased the volume of pages printed). However, a number of other operating plans have been
reflected in the budget in order to realise cost savings in excess of the reduction in revenue.
• Editorial cost savings appear to have been achieved by restructuring staff. It is unclear
whether editorial staff numbers have decreased or whether more expensive senior positions
have been replaced with lower paid roles, in effect reducing wage costs by 3.5% (wage rates
will increase by 3% to allow for inflation so it is expected that the budget would increase
by this amount. However there is a budgeted saving of 0.5% on this expense line).
• Although print volumes are relatively unchanged, printing costs have decreased by 7.5%,
reflecting a rate renegotiation in 20X4 as the cost per page will decrease by 7.7%.
• Distribution costs have increased by 0.2%, which is in line with the increase in the number
of copies distributed. It would appear that the agreement with the distributor is based on
a fixed cost per copy of $0.05 (and that the rate is not linked to inflation).
• Advertising wages reflect a significant reduction of $0.447 million. The budget may reflect
a restructure, however this information is not provided.
• Administration costs are in line with inflation.

ACT
The following steps outline a recommended approach for successfully completing this task.
Step 1 – Identify key factors

Key factors affecting organisations and their budgets are identified and discussed in the core
content. Historical performance, industry developments and changes, and economic trends and
conditions are particularly relevant to the scenario given.
Step 2 – Review the budget guidance provided by Green Coat’s head office
The guidance provided by Green Coat’s head office helps establish its expectations of financial
performance for 20X4.
Step 3 – Apply the key factors and performance expectations to Spree

Magazine’s budget
Guidance was provided that inflation is expected to be 3%. Therefore, if there were no changes
to the business, you would expect that expenses, including salaries and wages, would increase
by 3%.
Given that all of Spree Magazine’s revenue comes from traditional media advertising, you
would expect that revenue in 20X4 would decrease compared to the forecast for 20X3.
Given the decline in revenue, you would expect that cost saving initiatives would be reflected in
the 20X4 budget.
Step 4 – Identify the differences in financial performance between forecast 20X3

and budget 20X4
The budget template used by Spree Magazine clearly shows the variances between forecast
20X3 and budget 20X4, both in absolute dollars and as percentage changes.
Step 5 – Compare the change in financial performance to expectations

As all of Spree Magazine’s revenue comes from traditional media advertising, it would be
expected that the budgeted figure for 20X4 would decrease compared to the forecast for 20X3.
In this case it has decreased by 6% ($1.115 million).
Given the decline in revenue, there is the expectation that costs would be reduced, not only
to offset the expected revenue loss, but also to meet the expectation to improve profitability.
Profit is budgeted to increase by 15.4% ($0.133 million), while revenues have been budgeted to
decline by 6%; therefore, cost savings have been budgeted to be in excess of revenue losses, as
expected per the budget guidelines.
Not all costs have increased by the 3% inflation rate. Administration costs are in line with
inflation; however, all other costs, except for distribution costs, have decreased. Costs which
increase by less than inflation or which decrease would indicate that cost reduction plans have
been reflected in the 20X4 budget.
Step 6 – Identify interrelationships between financial and non-financial

information to help assess the underlying drivers of movements
Key operational statistics have been included in the budget submission. By assessing how these
relate to the financial figures, underlying causes for the change in financial performance can be
identified. Ratios and rates identified from the interrelationships between financial and non-
financial information are shown in each of the steps below.
Step 7 – Identify and assess the underlying drivers of revenue

Consider the nature of the business operations. The business unit is the publisher of a magazine
that obtains 100% of its revenue from advertising.

ACT
Advertising revenue has two components – price and volume. Units in this instance would be
the number of pages, while unit price would be the rate at which a page of advertising is sold.
Revenue is budgeted to decrease by 6%. The number of advertising pages (given in the scenario)
is budgeted to be down by only four pages (0.5%).
The advertising rate per page can be calculated by dividing revenue by the number of
advertising pages:
20X3 20X4 20X4 v. 20X3

Forecast Budget Variance +/(–) Variance %
Advertising revenue per page ($) 21,849 20,643 (1,206) (5.5)
This indicated that demand remains stable (supported by the fact that advertisers find it
to be effective); however, they are not willing to pay the same price (as they can move to
digital advertising).
Step 8 – Identify the variable costs that have moved in line with or outside of
expectations
By reviewing each expense line, costs can be categorised as either variable or fixed.
This categorisation will help you to understand the operational drivers impacting each line,
which then allows analysis to determine if movements are in line with expectations.
Variable costs and the driver(s) of those costs would be:
Variable costs Driver(s)
Editorial costs Wage rate, number of employees
Printing costs Number of copies printed, number of pages printed, number of issues
Distribution costs Number of copies distributed
Advertising wages Wage rate, number of employees
All costs are expected to increase by the inflation rate, unless other business plans have been
enacted.
Editorial and advertising wages are expected to increase by 3%; however, both costs have
decreased, and advertising costs quite significantly. This suggests that the other driver –
number of employees – has also changed. This could reflect a decrease in staff numbers. An
alternative explanation could be a change in staff mix (i.e. a restructuring to lower paid staff).
Printing costs have decreased by 7.5%. The number of issues is unchanged, but there has been
a small increase in the number of copies being printed and a small decrease in the number of
pages printed. This suggests that the rate that Spree Magazine pays for printing is expected to
decrease (as shown in the table below).
20X3 20X4
Forecast Budget
Number of printed pages (million) 2,496 2,495
Cost per 1,000 pages ($) 4.05 3.74
Average number of pages per issue 40 40
Distribution costs have increased 0.2%, which is in line with the increase in the number
of copies distributed for the same number of issues (up 0.2% also). This suggests that the
distribution agreement is based on a fixed cost per copy (and since there has been no change
year on year it is not linked to inflation).
20X3 20X4
Forecast Budget
Distribution cost per copy ($) 0.05 0.05

ACT
Step 9 – Identify the fixed costs to assess cost reduction plans that drive costs
The other costs appear to be more likely to be fixed.
Marketing is usually a discretionary cost, and it appears that Spree Magazine is planning to cut
its marketing spend in order to realise some of the savings desired by head office.
The increase in administration costs is 3%, which is in line with inflation.

ACT
Activity 5.4
Analysing budgets and sensitivity analysis
Introduction
Sensitivity analysis allows an organisation to consider various impacts on interrelated activities
as a result of changes to the assumptions. It can be applied to either budgets or forecasts to
determine the impact of changes in key variables on expected outcomes.
This activity will assist you in analysing a budget and help you to understand the
interrelationships between the different business performance drivers for the business. You will
also assess the sensitivity of the business’s margin to a change in one of those key drivers.
• Apply sensitivity analysis to business planning.
Scenario
Find Me Solutions (FMS) is an information technology company specialising in providing
software solutions to clients.
You have recently been employed by the company as an accountant. Your first task is to review
the draft annual budget (Table 1) for the period to 30 September 2021 and compare it under two
different scenarios.
Scenario 1
• Business confidence is low, with no growth forecast in gross domestic product (GDP).
• Low business confidence is expected to lead to a reduction in full-time equivalent (FTE)
direct staff to 76.
• The mark-up is to be reduced to 35%.
• Interest rates are expected to drop, impacting on finance expenses, with a forecast reduction
by 5%.
Scenario 2
• GDP is expected to grow by 2%; this is expected to increase direct staff numbers by 2.5%.
• Salary pay rates are to increase by 3%.
• The mark-up is maintained at 40%.
• Interest rates are expected to increase, impacting on finance expenses, with a forecast
increase by 2%.
Table 2 provides the assumptions for the draft annual budget.

Revenue is derived from a mark-up on salary. The assumption is that salaries are fully
chargeable to the clients. Non-chargeable salary expenses are part of the administration

ACT
expenses, which are part of overheads. Staff numbers are calculated on the basis of full-time
equivalents (FTEs).
Table 1: Financial performance information

Draft annual budget, Scenario 1 Difference
year ended 30 Sept. 2021 ( ) = unfavourable
Revenue $12,880,000 $11,799,000 $(1,081,000)
Direct costs:
Salaries $9,200,000 $8,740,000 $460,000
Gross profit $3,680,000 $3,059,000 $(621,000)
Gross margin (%) 29% 26% (3%)
Overheads:
Administration expenses $1,480,000 $1,480,000 $0
Sales and marketing expenses $740,000 $740,000 $0
Finance expenses $1,150,000 $1,092,500 $57,500
Total overheads $3,370,000 $3,312,500 $57,500
Operating profit $310,000 $(253,500) $(563,500)
Operating profit (%) 2% (2%)
Table 2: Draft budget assumptions

Draft annual budget, year
ended 30 Sept. 2021
Staff numbers (full time equivalents) – Direct 80
Average salary pay rate $115,000
Mark up % (based on salary) charge to clients 40%
Tasks
You are required to:
1. Analyse the initial draft annual budget for 30 Sept. 2021 compared to the Scenario 1 budget,
identifying the key factors, variables, drivers of performance and assumptions that underlie
the budgets.
2. Calculate and assess the budget under Scenario 2.

ACT
Solution
This activity involved analysing and appraising a draft budget against a change to the draft
budget based on changes to key factors, drivers of performance and assumptions.
Task 1
• The changes to the draft budget under Scenario 1 reflect a negative outlook on the future,
resulting in a negative impact on revenue. The underlying reasons are a nil growth in gross
domestic product (GDP), contributing to lower business confidence, and a lower interest
rate for borrowings.
• A reduction in the direct FTE staff numbers from 80 to 76 reduces the amount paid in
salaries, upon which the revenue is established.
• Contributing further to this reduction in revenue is the mark up reduction. With lower
business confidence and a nil growth in GDP, the mark up percentage charged to clients is
forecast to decline from 40% to 35%. The impact of these issues is shown by the following:
– A reduction of $1,081,000 in revenue for FMS (8% decrease on the draft budget).
– This extends to a decline in gross profit and reduces the gross margin to 26%.
– Overheads remain the same with the exception of finance expenses, which have
decreased due to the forecast interest rate reduction.
• The revenue decline, offset by the small decline in overhead expenses due to the reduction
in finance expenses, has led to a significant decline in operating profit (the draft budget’s 2%
profit margin declines to a negative 2%).
• FMS’s ability to charge-out the salaries via the mark up is a key driver of performance.
This requires maintaining staffing levels that can be fully utilised on client work.
• The mark up is also a key driver of profitability. Scenario 1 highlights a 5% drop in the mark
up percentage, contributing to a negative profit margin.
Task 2
Draft annual budget, Scenario 2 Difference
year ended 30.9.21 ( ) = unfavourable
Revenue $12,880,000 $13,598,060 $718,060
Direct costs:
Salaries $9,200,000 $9,712,900 $(512,900)
Gross profit $3,680,000 $3,885,160 $205,160
Gross margin (%) 29% 29% 0%
Overheads:
Administration expenses $1,480,000 $1,480,000 $0
Sales and marketing expenses $740,000 $740,000 $0
Finance expenses $1,150,000 $1,173,000 $(23,000)
Total overheads $3,370,000 $3,393,000 $(23,000)
Operating profit $310,000 $492,160 $182,160
Operating profit (%) 2% 4% 2%

ACT
• The positive outlook in Scenario 2 leads to increased staff numbers, an increase in salary
pay rate, and – applying the same mark up as per the draft budget, increases revenue by
$718,060.
• By maintaining the draft budget mark up and maintaining overhead expenses (with the
exception of the increase in finance expenses of $23,000) the profit margin increases from 2%
to 4%.

ACT
Activity 5.5
Developing and analysing a budget
Introduction
The translation of strategic and operational plans into financial plans in the form of budgets
and forecasts is a key aspect of a management accountant’s role. Identifying key variables,
understanding their implications, and communicating them are all essential in developing a
robust budget or forecast.
For this activity you are required to identify key drivers, constraints and assumptions affecting
the entity’s new budget.
Scenario
You are a recently appointed management accountant at Young Rebels Limited (Young Rebels).
One of your first tasks is to provide the Chief Financial Officer (CFO) with the proposed budget
for 20X9 (year ended 31 December 20X9). The previous management accountant has already
completed an initial budget for 20X9 and you now have available the latest forecast position
for the year ended 31 December 20X8 to help you make any adjustments to the initial budget.
This forecast is based on nine months’ actual (January 20X8–September 20X8), and three
months’ forecast (October 20X8–December 20X8). You also have available the previous budget
for the year ended 31 December 20X8.
Young Rebels Limited

Young Rebels has 10 retail stores across the country. The company segments its product
range under three main categories –household goods, furniture and sporting merchandise.
The company has a strong customer base built upon 15 years operating as Young Rebels across
the three segments. The company is a family owned business. A new Chief Executive Officer
(CEO) was appointed in early 20X8 and she is keen to establish challenging targets in her
first budget.
Key drivers and assumptions

The company’s strategy for 20X9 is to deliver a minimum growth of 5% in revenue and
operating profit. This is to be achieved through efficiency gains in inventory management,
better control of overhead costs and a new centralised distribution centre to be operational from
April 20X9.
The competition in the market for the main product lines have intensified over the past two
years. This competition is mainly coming from online competitors for sporting merchandise.
To date Young Rebels has given online sales a low priority with limited resource allocation.

ACT
The company places a priority on the in-store shopping experience of its customers. As such an
upgrading of various stores to achieve a consistent and improved store experience is planned for
20X9. Major renovations are planned for three stores to bring them up to the standard expected.
These upgrades will be supported by additional promotional activity as the renovations for each
store are completed. There were no major promotional activities during 20X8.
Assumptions regarding the external environment include

• Inflation rate of 1.5%.
• Interest rates remaining at similar levels to 20X8.
• Consumer demand and confidence are expected to increase from 20X8 levels.
• Exchange rates are expected to be at similar levels to 20X8.
Internal key factors

• Additional resources are to be allocated to improving online sales in 20X9.
• Products are sourced both domestically and overseas. The target for 20X9 is to source
domestic suppliers for 25% of the product (this represents a 5% increase from 20X8).
Income statement Budget 20X9 Budget 20X8 Latest forecast 20X8

(year ended (year ended (year ended
31 December 20X9) 31 December 20X8) 31 December 20X8)
$’000 $’000 $’000
Sales 67,317 66,800 64,760
Cost of goods sold (COGS) 37,024 38,212 36,992
Gross profit 30,293 28,588 27,768
Store expenses 9,097 9,060 9,212
Advertising expenses 3,220 3,420 3,217
Distribution expenses 2,980 2,990 3,182
Administration expenses 8,615 8,290 8,194
Interest expense 2,050 2,100 1,865
Operating profit 4,331 2,728 2,098
Tasks
1. Analyse the proposed budget for 20X9.
2. Provide any recommendation of changes that should occur to ensure greater accuracy of
the 20X9 budget.

ACT
Solution
Task 1
An analysis of the proposed budget would include:
Operating Profit
The operating profit for budget 20X9 has increased by $2,233,000 from the latest forecast for
20X8, representing an increase of 106%. While the new CEO ‘is keen to establish challenging
targets in her first budget’ this budget profit seems too optimistic and overly challenging.
The operating profit margin for budget 20X9 is 6.4%, a significant increase from both the budget
20X8 of 4.1% and the latest forecast for 20X8 of 3.2%. A further analysis of the revenue and
expenses will identify the underlying causes for the profit increase.
Sales
Sales growth for the budget 20X9 is 3.95% from the latest forecast for 20X8. This is below the set
target growth of 5%. The contributing factors to the expected increased sales appear to be the
expected increase in consumer demand from 20X8 and a greater presence of online sales, offset
by the strong competition.
Expenses
COGS is the most significant expense item. The budget 20X8 COGS was 57.2% of sales, and
is maintained at a similar level for the forecast 20X8 at 57.1% of sales. The budget 20X9 has
declined to 55% of sales. This small decline has contributed to an increase of $2,525,000 from the
forecast for 20X8 to the budget 20X9 at the gross profit level. The gross profit margin increases
to 45% for the budget 20X9 from 42.9% in the forecast 20X8. Justification for this increase is not
apparent, therefore maintaining the percentage from 20X8 may be more appropriate, as the
economic environment states exchange rates for 20X9 are expected to be at similar levels to
20X8. With approximately 75% of products sourced from overseas the COGS appears to be
understated. The inflation rate of 1.5%, although low, would justify a marginal increase in
COGS (absolute amounts) rather than a significant reduction.
Store expenses have dropped to 13.5% of sales in the budget 20X9 from 14.2% of sales in the
latest forecast – an overall decrease of $115,000. The planned renovations in 20X9 would be
mainly capitalised; however, there could be an anticipated increase in these expenses as part
of the renovations planned for 20X9.
Advertising expenses have remained constant ($3,000 difference) for 20X9; however, this should
show an increase from the 20X8 forecast due to the promotional activities planned for 20X9.
Distribution expenses are showing a $202,000 decrease in the 20X9 budget from the latest
forecast for 20X8. The timing of the gains from the centralised distribution centre will only occur
after April and therefore the savings should not be too optimistic for budget 20X9.
The administration expenses are showing a significant increase of $421,000 in the 20X9 budget
from the latest forecast. Part of this can be justified with the increase in sales activity, and an
allowance for inflation; therefore, the percentage of administration expenses to sales appears
reasonable as it shows a marginal increase from 12.7% in the latest forecast to 12.8% in the
budget 20X9.
Interest expenses indicate an increase of $185,000 in the 20X9 budget from the latest forecast.
This is surprising given the interest rate stability projected. Debt levels may have risen due to
the renovations planned for the stores in 20X9.

ACT
Task 2
Recommendations
Investigate further and/or adjust the proposed budget for 20X9 in the following areas:
• Sales target currently has not achieved the growth strategy target of 5%. Assess
opportunities to further increase sales above the 20X8 forecast. Also take into account that
consumer demand and confidence are expected to increase.
• Investigate the COGS to ensure the validity of this number, which currently appears to be
too low.
• Investigate the store expenses and clarify the renovation work and its impact on this
expenses category.
• Adjust advertising to reflect the anticipated increase in promotional activities.
• Adjust distribution expenses to allow for expected increase in costs in the short term for 20X9.
• Investigate the administration expenses to determine the validity of the increase from the
forecast 20X8.
Summary of analysis
Budget Percentage Forecast Percentage Difference between
20X9 of sales 20X8 of sales budget 20X9 and
forecast 20X8
% % $‘000
Sales 67,317 64,760 2,557
COGS 37,024 55.0 36,992 57.1 (32)
Gross Profit 30,293 45.0 27,768 42.9 2,525
Store expenses 9,097 13.5 9,212 14.2 115
Advertising expenses 3,220 4.8 3,217 5.0 (3)
Distribution expenses 2,980 4.4 3,182 4.9 202
Administration expenses 8,615 12.8 8,194 12.7 (421)
Interest expenses 2,050 3.1 1,865 2.9 (185)
Operating profit 4,331 6.4 2,098 3.2 2,233

ACT
The following steps outline a recommended approach for successfully completing these tasks.
Step 1 – Identify key factors

Key factors affecting organisations and their budgets are discussed in the scenario. Historical
performance from the latest forecast (20X8), key drivers of the company’s strategy for 20X9,
and economic trends and conditions are all relevant.
Step 2 – Review the proposed budget

Review the proposed budget and establish key differences to the latest forecast for 20X8.
Providing analysis to the budget 20X8 is not as relevant and therefore the focus is on
comparisons between the latest forecast for 20X8 and budget 20X9.
Step 3 – Apply key factors and performance expectations and

identify the differences
Apply the key facts from step 1 to the proposed budget 20X9 and establish the revenue and
expense lines that appear to be inconsistent with the key factors from the scenario. For example,
the operating profit has increased significantly in the proposed budget for 20X9 – this is not
consistent with the 20X9 strategy.
Step 4 – Compare the change in financial performance to the

expectations and scenario information provided
Key areas of difference appear to be in COGS, store, advertising, distribution and
administration expenses. Overall, the significant increase in operating profit for the budget
20X9 shows an increase of 106% from the latest forecast for 20X8. The economic conditions and
outlook for the organisation do not appear to justify such as dramatic increase.
Step 5 – Provide a set of recommendations

Provide a set of recommendations that require further investigation or an adjustment to the
proposed budget to provide a greater level of accuracy, given the scenario information and
historical data.

ACT
Activity 5.6
Analysing a budget, a strategy and related
key performance indicators
Introduction
This is an integrated activity combining the topics of business planning, performance analysis,
performance measurement and management, and strategy.
For this activity you are required to analyse a draft budget, provide relevant key performance
indicators and benchmarks for the organisation, and identify and justify the strategy
being undertaken.
• Outline generic strategies that organisations use (Unit 1).
• Develop appropriate key performance indicators (Unit 4).
• Analyse the key factors, constraints, and assumptions in developing a budget or
forecast (Unit 5).
• Design appropriate benchmarking measures and assess the outputs of a benchmarking
exercise (Unit 6).
Scenario
You are a Chartered Accountant working for a large travel agency called Best Travels. You
report to the chief executive (CE) and your key responsibilities include preparing the budget
and analysing the profitability of the business segments.
Best Travels has branches located in all major cities across Australia and New Zealand. It offers
travel deals to many destinations and specialises in travel deals to Thailand (80% of the
budgeted revenue) and the United Kingdom (UK). Best Travels has specialist staff who serve
clients travelling to Thailand or the UK, and non-specialist staff who serve clients travelling to
other destinations.
The success of Best Travels relies on the ability of its staff to arrange packaged deals for
clients and provide solutions for complex travel requirements. The packaged deals usually
comprise tours of local places and attractions, plus accommodation. These deals are not readily
available online.
The staff’s knowledge in their countries of expertise (i.e. Thailand and the UK) is critical in
converting client enquiries into travel bookings. The staff recognise the importance of getting
clients in the door to discuss their travel needs, at which point the staff aims is to secure a
deposit from the clients before they leave Best Travels’ premises.
Best Travels is a prominent and frequent participant in travel fairs in local regions, which forms
a large part of the ‘Advertising and promotions’ expense item.

ACT
The budget process is running late and the actual results for the year ending 30 June 20X9 have
already been completed.
Table 1 outlines the financial information for the 20Y0 draft budget compared to the actual
results for 20X9:
Table 1: Financial information

20Y0 20X9
Budget Budget Budget Variance

Budget United Other Unallocated Budget ()= % change
Thailand Kingdom destinations Expenses Total Actual unfavourable ()=
$’000 $’000 $’000 $’000 $’000 $’000 $’000 unfavourable
Fee revenue 15,422 2,876 980 19,278 21,420 (2,142) (10%)
Expenses
Salaries and 6,985 3,896 936 11,817 12,915 1,098 9%

employee
benefits
Advertising 1,408 1,408 1,442 34 2%

and
promotions
Lease 448 598 42 1,088 1,056 (32) (3%)

expenses
Staff training 260 420 68 748 998 250 25%
Office 688 1,102 48 1,838 1,495 (343) (23%)

expenses for
staff
General 1,420 1,420 2,524 1,104 44%

administration
Interest 840 840 810 (30) (4%)

expense
Total 8,381 6,016 1,094 3,668 19,159 21,240 2,081 10%

expenses
Profit 7,041 (3,140) (114) (3,668) 119 180 (61) (34%)

before tax
Table 2: Staffing information

20Y0 20X9
Budget Budget Budget

Budget United Other Unallocated Budget
Thailand Kingdom destinations Staff Total Actual Difference
Number of 82 31 6 12 131 135 4

employees
(full-time
equivalents)

ACT
The CE has now given you the following guidance to be factored into the draft budget 20Y0.
• Inflation is expected to be 2% p.a.
• Interest rates are expected to increase throughout 20Y0.
• Salary and wages are not expected to increase in 20Y0.
• Staff turnover rates have been increasing each year.
• Discretionary spending needs to be reduced from 20X9 levels.
Travel industry data highlights more airlines are operating between Asia and Australasia where
several airports have been upgraded to enhance travel experience.
The following events have occurred since the draft budget was prepared:
• The UK currency has declined against all currencies.
• Thailand currency has appreciated against all currencies.
• A major competitor has recently entered the market. This competitor offers a reduced fee
structure and utilises its global connections to provide low-priced package deals.
Tasks
1. Analyse the draft budget for 20Y0 taking into account:
• The guidance, assumptions and the industry data.
• The events that have occurred after the preparation of the draft budget.
2. The chief executive requires the company to have non-financial key performance indicators
(KPIs) and internal financial benchmark measures. The KPIs are to monitor organisational
performance and the internal benchmarks are to monitor branch performance. Identify
and explain four (4) non-financial KPIs and two (2) benchmark performance measures
that would be suitable for Best Travels.
3. Identify and justify the generic strategy that will be pursued by Best Travels in 20Y0.

ACT
Solutions
Task 1
Fee revenue
The fee revenue for the 20Y0 draft budget represents a decrease of 10%, which aligns with
the following information:
• A new competitor entering the market and offering low priced package deals. This may
have a major impact on the fees Best Travels will earn in the budget year.
• The appreciation of the Thai currency, making it more expensive to travel to Thailand
(80% of the budget revenue).
However, offsetting the above potential decreases to revenue are the following points:
• Better traveller experience, encouraging greater numbers to travel.
• More options offered by airlines for travels to Asia (Thailand).
• Favourable UK currency movement is making travel to the UK cheaper (15% of
the budget revenue).
• With inflation at 2%, there could be an expectation that there would be an increase in fees in
line with inflation therefore an increase in revenue.
Salaries and employee benefits

• The 9% decrease in the draft budget aligns with the 10% decrease in the fee revenue.
However, given that staff are a critical success factor for Best Travels, a 9% reduction may
not be appropriate.
• The actual expenses in this account for 20X9 per employee was $95,667 ($12,915,000/135),
and this decreased in the draft budget to $90,206 ($11,817,000 /131), representing a 5.7%
decrease. Would normally expect an increase to reflect the inflation increase, however there
is guidance given that no increases are expected for salaries and wages. The 5.7% decrease
may be due to the increasing staff turnover rate, which causes new employee starting rates
to be lower than the rates of employees leaving Best Travels.
Advertising and promotions

• Advertising and promotion has declined by 2%. Although this is not significant, this would
be expected to increase in line with inflation and a possible increase above inflation to
capture some of the market that appears to be lost or potentially lost to the new competitor.
• This appears to be a reduction in discretionary spending for advertising (as required by the
CE), and yet this expense category is important for the business. Also an increase could be
expected to capture the favourable industry trends of traveller experience and increased
airline offerings.
• This is a critical expense item which includes the participation in regional travel fairs.
We would expect this to be in line with inflation increases.

ACT
Staff training
• Staff training expenses are not in line with the standard inflation increase, and have
decreased by 25%. This appears to be a reduction in discretionary spending (as required
by the CE) for training, and yet this expense category is important for the business.
• This is a critical success factor and therefore needs to have the right amount of resources
allocated. It is currently showing a 25% decrease for the draft budget 20Y0, which does not
align to the importance of staff training.
• The increasing staff turnover rates would potentially cause additional staff training costs,
rather than the 25% decrease in the draft budget for 20Y0.
Profit before tax by segment and total

• The profit before tax segment for Thailand is the only segment showing a positive
contribution ($7,041,000), before any of the expenses that are unallocated. The cost structure
for the UK segment has higher costs in the draft budget 20Y0, except for salaries expense
line, while the UK segment is only contributing 15% of the revenue.
• The cost structure for salaries and employee benefits for Thailand is $85,183 per employee
($6,985,000/82), compared to $125,677 ($3,896,000/31) for the UK, and $156,000 ($936,000/6)
for other regions. This needs further investigations to determine if the organisation should
continue serving clients for these segments, given the negative contribution and high
cost structures.
• Overall profitability has decreased by $61,000, with the draft budget showing both declining
profit and declining revenue from actual 20X9.
General analysis points

• Office expenses for staff – this represents an increase of 23% for the budget compared to
actuals for 20X9. This could be considered as part of the discretionary spend and therefore
the increase is not in line with the CEs directive. This expense line could also be expected
to increase with inflation and offset by the reduction of staff numbers by four full time
employees (3%). The 23% increase would seem excessive.
• Further analysis required on the general administration of $1,420,000 (unallocated). In
addition, it needs to be determined if some of this amount can be appropriately allocated to
a segment. The reduction of $1,104,000 represents a significant decrease in the budget and
impacts the overall budget profit.
• As the other markets utilises six staff, further investigation is required to determine whether
the staff should be better used in the Thailand or the UK market.
• Interest expense has increased by $30,000 (4% increase). This would seem to align with
interest rate increases expected throughout 20Y0.

ACT
Task 2
KPIs – any four from the following:
• Market share percentage per month/quarter – determine from industry data how much
additional market share the company has achieved, given its advertising, new competitor
and the expected increase in travel. Monitor on a monthly/quarterly basis, if the information
is available.
• Travel fair events in regions – monitoring the numbers attending and the conversion of
enquiries from clients into deposits/travel made. This can be monitored on an event basis
as they occur.
• Staff training – in hours/ trips – ensuring staff training is maintained to keep the knowledge
of staff current and relevant to their areas of expertise. The KPI established on a monthly/
quarterly/half yearly.
• Conversion rate of clients the staff talk to on the premises and those who pay a deposit
before leaving. This can be monitored on a frequent basis (e.g. per week).
• Post trip client satisfaction survey which requires a rating of the service they received and
whether their expectations from their trip have been met. Complete this survey on a per
quarter basis.
• Staff retention rate per quarter – monitoring staff’s satisfaction with the organisation, given
the importance of staff to generate revenue. This could be an employee satisfaction survey.
• Number of packaged deals available to customers – establishing a minimum requirement in
any period, given the importance of deals that separate the business from online sales.
• Staff turnover rate per month/per quarter – monitor more frequently if the rate continues
to increase. To understand these numbers and underlying reasons for these rates, exit
interviews would be insightful.
Benchmarks
The following provide a range of benchmark measures that could be used to assess comparisons
between branch operations. The aim of the benchmark is to support performance comparisons
between the operational units of the organisation (in this scenario the branches that exist across
Australia and New Zealand).
Any two from the following benchmarks:

• Fee revenue per branch based on a square metre. Basing it on a square metre enables
a comparison between branches irrespective of branch size.
• Average branch fee revenue per employee. This will support the relevant comparisons
to employee numbers in each branch to the fees earned in the branch.
• Expense items per branch (at the levels of salaries, lease expenses, staff training, office
expenses) per employee/or per square metre. This enables a relevant comparison of the
cost structures and staff levels at each branch.
Task 3
Strategy pursued by Best Travels in 20Y0
Differentiated
• Specialises in offerings to Thailand.
• Provides solutions for complex travel requirements.
• Travel deals and packages not available online.
Broad
• Across all major cities in Australia and New Zealand.

ACT
Unit 6: Analysing actual performance I
Activity 6.1
Ratio analysis
Introduction
This activity requires you to calculate, interpret and analyse financial ratios, evaluate the
financial performance of the company, and recommend courses of action for the chief financial
officer (CFO).
• Evaluate financial ratios and trends used to analyse the financial performance of
an organisation.
At the end of this activity you will be able to evaluate an organisation’s financial performance
and identify the actions management need to take to improve future performance.
Scenario
You are the management accountant at Tycon Limited (Tycon), reporting to CFO Sally Lin.
Tycon has been in the retail business for 30 years and has established and maintained a strong
corporate brand. The brand is associated with providing quality products at a reasonable
price. Tycon extended the retail business eight (8) years ago with the acquisition of an existing
business of retail stores selling sports equipment, sports clothing and sports footwear. Now the
stores are in a separate division, under the ‘Hit’ brand. The company operates two (2) divisions
– Tycon, which sells homeware products, and Hit, which sells sports-related products. There are
a total of 36 stores nationwide, with four (4) new stores across the two divisions added during
the 20X8 financial reporting period. Imported purchases represent approximately 90% of the
products sold.
You have obtained the following information on the 20X9 financial performance:
• Promotional plans had to be changed in light of a slow start to the winter period and lower
demand. Seasonal stock had, however, already been committed and stock levels could not
be adjusted to reflect the lower demand.
• The proportion of sports-related products, especially sports apparel, in the product mix
increased in comparison with the previous year.
• A new inventory system is planned for full implementation in 20Y0. The initial pilot
testing of the system in four (4) stores identified a number of significant issues to address.
These issues are expected to be resolved before implementation in 20Y0.
• The gross margin increased, supported by a strengthening local currency.
• Online sales were static. The expected growth in this segment did not occur.
maaf12106_act_01

ACT
The following financial information for Tycon Limited has been obtained:
Balance sheet 20X9 20X8 20X7

($’000) ($’000) ($’000)
Current assets
Cash 18,072 20,500 20,638
Accounts receivable 578 604 613
Inventories 22,671 19,864 19,788
Total current assets 41,321 40,968 41,039
Total inventories for 20X6: $19,230
Non-current assets
Property, plant and equipment 22,917 13,460 12,790
Intangible assets 531 402 382
Total non-current assets 23,448 13,862 13,172
Total assets for 20X6: $43,880
Current liabilities
Accounts payable 14,271 13,690 13,580
Provisions 16 15 17
Tax payable 195 240 225
Total current liabilities 14,482 13,945 13,822
Accounts payable for 20X6: $13,490
Non-current liabilities
Employee benefits 199 188 187
Other liabilities 10 10 10
Total non-current liabilities 209 198 197
Net assets 50,078 40,687 40,192
Net assets for 20X6: $40,002

ACT
Income statement 20X9 20X8 20X7

($’000) ($’000) ($’000)
Revenue 185,162 176,755 175,198
Cost of goods sold (107,394) (105,825) (104,602)
Gross profit 77,768 70,930 70,596
Other operating income 1,494 64 68
Store expenses (40,442) (32,986) (31,842)
Administration expenses (21,775) (21,478) (21,460)
EBIT 17,045 16,530 17,362
Finance income 675 702 680
Profit before income tax 17,720 17,232 18,042
Income tax expenses (5,486) (4,840) (5,060)
Net profit attributable to shareholders 12,234 12,392 12,982

ACT
The following table shows Tycon’s financial ratios for the past three years.
Item Description 20X9 20X8 20X7
Current ratio Current assets 41,321 40,968 41,039
Current liabilities 14,482 13,945 13,822
2.85: 1 2.94: 1 2.97: 1
Quick ratio Current assets – Inventories 18,650 21,104 21,251
Current liabilities 14,482 13,945 13,822
1.29: 1 1.51: 1 1.54: 1
Inventory days Average inventory × 365 7,762,637 Calculate Calculate

Cost of goods sold 107,394
72.28 days
Creditor days Average creditors × 365 Calculate Calculate Calculate
purchases
Return on equity NPAT 12,234 Calculate 12,982
Average ordinary shareholders funds 45,383 40,097
27.0% 32.4%
Gross margin Sales – COGS 77,768 70,930 70,596

Sales 185,162 176,755 175,198
42.0% 40.1% 40.3%
Operating expenses Operating expenses 62,217 54,464 53,302
Sales 185,162 176,755 175,198
33.6% 30.8% 30.4%
EBIT margin EBIT 17,045 16,530 17,362
Sales 185,162 176,755 175,198
9.2% 9.4% 9.9%
Return on assets EBIT Calculate Calculate 17,362
Average total assets 49,046
35.4%
Debt to equity ratio Total liabilities 14,691 Calculate 14,019
Total equity 50,078 40,192
0.29: 1 0.35: 1
Net margin NPAT 12,234 12,392 12,982
Sales 185,162 176,755 175,198
6.6% 7.0% 7.4%
Tasks
1. Calculate the financial ratios that are not shown in the above table (i.e. in the table cells
marked ‘calculate’)
2. Analyse the results of the ratios, margins and trends over the period 20X7 to 20X9.

ACT
Solution
Task 1
The calculation of the ratios is as follows:
Item Description 20X9 20X8 20X7
Inventory days Average inventory × 365 7,762,637 7,236,490 7,120,785

Cost of goods sold 107,394 105,825 104,602
72.28 days 68.38 days 68.08 days
Creditor days Average creditors × 365 5,102,883 4,976,775 4,940,275

Purchases 110,201 105,901 105,160
46.31 days 46.99 days 46.98 days
Return on Equity NPAT 12,234 12,392 12,982

Average ordinary shareholders funds 45,383 40,440 40,097
27.0% 30.6% 32.4%
Return on assets EBIT 17,045 16,530 17,362

Average total assets 59,800 54,521 49,046
28.5% 30.3% 35.4%
Debt to equity Total liabilities 14,691 14,143 14,019

ratio Total equity 50,078 40,687 40,192
0.29: 1 0.35: 1 0.35: 1
The steps below outline the recommended approach for successfully completing this task.
Step 1 – Apply the ratio formula to the missing calculations

Review the CSG content for Unit 6 to ensure that you apply the correct formula to the
remaining ratios that need to be calculated.
Task 2
The analysis of the ratios, margins and trends for each item is as follows:
Item Analysis
Current ratio The current ratio is substantially greater than 1, indicating that Tycon has sufficient
current assets available to meet its current liabilities. A key factor causing the decrease
in the current ratio in 20X9 was the reduction in the cash balance
Quick ratio The quick ratio is significantly lower than the current ratio, reflecting the large
investment in inventory. Although the ratio remains greater than 1, indicating there are
no immediate liquidity issues, the ratio trend since 20X7 has been getting lower from
1.54:1 in 20X7 to 1.29:1 in 20X9. Similar to the current ratio, the key cause of the lower
quick ratio in 20X9 is the reduction in cash of $2.428 million in 20X9
Inventory days Inventory days have increased since 20X8 (72.28 days in 20X9 compared to 68.38
days in 20X8). A slow start to the winter period and lower demand. A second factor
contributing to higher inventory levels was that seasonal stock purchases had already
been committed and stock levels could therefore not be adjusted to reflect the lower
demand
Creditor days Creditor days has remained relatively consistent over the three year period. Creditors in
dollar terms has increased by $691,000 due to higher purchases (caused by higher cost
of goods sold and inventory levels over the three years). This would have a negative
impact upon cash

ACT
Item Analysis
Return on equity ROE has steadily decreased over the three year period. This is due to two factors:
decreasing NPAT (see comments on gross margin / operating expenses / EBIT) as well
as a large increase in “Average ordinary shareholders funds” caused by an increase in
property, plant and equipment of $9.457 million in 20X9. The investment in four new
stores during the 20X9 financial reporting period would have contributed to this increase
Gross margin Gross margin increased from 40.1% in 20X8 to 42% in 20X9, this could be linked to
changes in the product mix, with an increase in sports-related product sold through the
Hit stores
Operating expenses A significant increase in store expenses from $32,986,000 in 20X8 to $40,442,000
in 20X9 caused a 2.8% increase in operating expenses/ sales. The only information
available in the scenario to explain this is the development of four new stores during
the 20X9 financial year. However the cause of store expenses increasing at a higher rate
than sales needs to be investigated (no information regarding the cause of this increase
has been provided in the scenario)
EBIT margin EBIT margin trend declined over the period 20X7 – 20X9. In 20X7 the margin was
9.9%, in 20X9 this declined to 9.2%. This decline occurred despite an increase in gross
margin in 20X9, and the positive effect of the other operating income. The reason for
this decline in the EBIT margin has been the increase in store expenses (see comments
above regarding operating expenses)
Return on assets There was a significant increase in property, plant and equipment over the period
20X7 – 20X9. The return on total assets declined in 20X9, although by year end it was
still a healthy return of 28.5%. There was also the positive effect of the other operating
income in 20X9
Debt to equity ratio The debt to equity ratio reduced from 0.35 in 20X7 and 20X8 to 0.29 in 20X9. Positive
operating cash flows continue to ensure a very low debt to equity ratio, together with
increasing equity levels. Total liabilities has remained relatively constant over the three
year period and therefore would not have impacted upon the debt to equity ratio. The
significant reduction of the debt to equity ratio was caused by the increase in total
equity of $9.391 million in 20X9. The reason for this increase would have been to finance
the investment in property, plant and equipment
Net margin The net margin trend since 20X7 has also been declining, from 7.4% in 20X7 to 6.6% in
20X9. A factor impacting upon this decline is that the income tax expense has increased
from 28.1% of PBIT in 20X8 to 31% in 20X9
Notes: Debtors days is not considered an issue as the accounts receivable balances
are insignificant – in the type of retail industry in which Tycon operates, customers
generally pay immediately
The steps below outline the recommended approach for successfully completing this task.
Step 1 – Clarify your understanding of each ratio and margin calculation

Review the CSG content for Unit 6 to ensure that you have a sound understanding of each ratio,
how it links with other ratios and what it means for assessing organisational performance.
Remember that a ratio should not be interpreted in isolation, and that completing trend
analysis on ratio results can provide evidence of issues to address or help identify strengths of
the company.
Step 2 – Assess changes in the financial ratios and margins

Review each ratio, and the changes that occurred over 20X8 and 20X9. To support any trend
analysis and throw more light on significant changes in ratios over the period, it would also be
advisable to review the ratios for 20X7.
Assess whether the performance has improved or declined. Based on your reading of
the scenario and the financial information provided, determine a reason for any change
in performance.

ACT
Activity 6.2
Identifying appropriate benchmarking
partners and issues
Introduction
This activity requires you to follow the initial steps of the benchmarking process to determine
what parts of a business are appropriate to be benchmarked, and identify appropriate
benchmark partners to use.
The activity links to unit learning objectives:
• Apply the initial steps of the benchmarking process to determine what parts of a business
are appropriate to be benchmarked.
• Design appropriate benchmarking measures and assess the outputs of a benchmarking
exercise.
At the end of this activity you will be able to identify appropriate benchmarking partners
and issues.
Scenario
You are the management accountant for InsideHome.
InsideHome is an Australian-owned chain of homeware stores which sells its own brand
product range, as well as other well-known brands.
It has 21 stores across Australia in both cities and regional locations, with more planned for
the next year.
InsideHome has also just launched an internet site that contains product information and
a limited range of products for sale.
InsideHome is considering a benchmarking exercise to measure its performance and provides
the following information:
Inventory supply process

InsideHome’s own brand products are designed in Australia and manufactured in the
Philippines. The company buys in bulk and warehouses the products in its Melbourne
warehouse. There is a six-month lead time between placing an order with the Philippine
manufacturer and receiving the goods at the Melbourne warehouse.
With the launch of each season’s new products, each store is shipped a start-up order based
on the particular store’s floor size. After the initial order, the stores place orders with the
warehouse for additional stock as required.

ACT
Product pricing
While head office has a recommended price list, each store can price its products according to
the level of local competition.
At the end of the season, any unsold items are returned to head office at the same cost they were
transferred to the store for. They are then disposed of at InsideHome’s outlet store.
Customer service
InsideHome prides itself on its customer service.
It assesses the performance of its stores by using mystery shoppers (fake customers posing
as real customers who go into stores to make purchases). It also operates a customer email list
advising customers of sales and special offers exclusive to email list subscribers.
Marketing and promotion

All marketing is conducted by head office, except for local promotional campaigns.
Competitors
The well-known homeware brands that InsideHome sells are also available in department
stores and other homeware stores.
InsideHome’s biggest direct competitor is Baywares, a US publicly listed company, with 150
stores worldwide. Its product range is entirely comprised of its own innovative designs, which
are manufactured exclusively in China.
Other information
Each store manager determines the staffing level required, including the mix of permanent
and casual employees.
Head office pays all employees and suppliers, as well as locating and setting up new
store locations.
Tasks
1. Identify products, services or processes that InsideHome could benchmark.
2. Identify the different benchmark partners, both internal and external to the organisation,
that could be used in a benchmarking exercise, explaining the benefits and risks of using
each partner identified, and linking the partners you have identified to the specific
products, services or processes identified in Step 1.
3. Specifically consider the online store and:
(a) Identify the issues in benchmarking the online store against the physical retail stores.
(b) Outline how you would use benchmarking to assess the performance of the online store.

ACT
Solution
Task 1
InsideHome could use the following products, services or processes as benchmarks:
• Sales – including performance of InsideHome brands versus other brands and online store
figures versus retail outlet store figures.
• Gross margin – assessment of pricing policies and product mix per store.
• Staffing – cost, number, and mix of casuals and permanents.
• Distribution of product to stores – length of time versus costs.
• Customer service – individual stores’ performance against other stores and retailers.
• Supply lead times – length of time between placing orders, manufacture in the Philippines
and delivery to the warehouse.
• Inventory management – ordering levels, amount of product disposed of at the outlet shop.
• New store set-up process – length of time versus costs.
• Accounts payable and payroll processes.
• Product design process – costs versus number of staff.
The steps outline the recommended approach for successfully completing this task.
Step 1 – Consider the key operational aspects of the business

Consider the key operational aspects of the business that are critical to its success. You could
prepare a value chain to help with this process.
Step 2 – Identify benchmarks

Identify factors that could be compared and would provide insight into the efficiencies of
processes or operational performance.
Task 2
InsideHome could use the following benchmark partners in a benchmarking exercise:
Partner Benefits and risks Products, services or processes to

benchmark
Own physical • Information is readily available • Sales and gross margins (as stores control
stores • A good way to assess the performance these to the extent of deciding what to
of each store, particularly if variables stock and the selling price). Also, profit per
such as the size of the store are removed store
by using a measure such as ‘x per square • Staffing (could look at staff cost per square
metre’ metre or headcount to assess efficiency)
• Internal focus, which may mean not • Customer service (as mystery shoppers
gaining knowledge of what competitors will provide a comparable rating)
are doing • Inventory levels and stock-outs to ensure
that service levels and inventory are
appropriate
Physical stores • Information is readily available • While comparisons can be made, this
versus online and • Different customer distribution channels comparison will be difficult to benchmark,
outlet stores need to be taken into account when as the cost of doing business and sales
selecting which areas to benchmark prices will vary dramatically (refer Task 3
below)

ACT
Partner Benefits and risks Products, services or processes to

benchmark
Other retailers • Some information will be available for • Customer service

including publicly listed organisations • Staffing levels
department • Allows comparison against external • Inventory management and distribution
stores organisations to find best practice to to stores (if similar size)
measure against
• New store set-up costs (if in a growth
• Provides a useful comparison if one stage like InsideHome)
could find a retailer of similar size, which
• Internal processes such as payroll and
is also growing
accounts payable, which should be
operating under similar trading conditions
• Manufacturing and importing (if retailers
have comparable processes)
Baywares • Publicly listed, so some information may • Sales per employee or per square metre
be available, but not all of floor space might provide a useful
• Global operation, with different comparison
associated costs when compared to • Similarly with customer service
a local Australian operation • May be difficult to get information on
• Foreign company, so exchange rate may manufacturing, importation and product
distort financial comparisons design
• Could help with establishing a best
practice target benchmark
• Global operation where geographic
location may influence price and
product range
Step 1 – Identify benchmark partners

Consider the different benchmark partners, both internal and external to the organisation.
Step 2 – Identify the benefits and risks

Identify the benefits and risks of using each partner identified.
Step 3 – Link partners to benchmarks

Match the partners you have identified to the specific products, services or processes identified
in Task 1.
Task 3
When benchmarking the online store, InsideHome should be aware of the issues in
benchmarking it against the physical retail stores.
The online store:
• Is new, while the physical stores have been trading for a longer period of time.
• Has a different distribution channel, which should lower costs per sale (e.g. staff costs are
less, there is no rent, and marketing costs are less, as the website does not have to target
a local community and benefits just as much as the physical stores do from head office
promotions), and has different selling prices.
• Does not order and hold inventory, as it sells directly from the warehouse stock.
The performance of the online store could be better assessed by measuring InsideHome against
other online retailers, in particular those that have a mix of online and physical stores.

ACT
Possible benchmarks include:
• The mix of sales between online and physical locations.
• The difference in cost per sale between online and physical stores.
• The delivery time from taking the order to its despatch to the customer.
Step 1 – Identify issues

Identify the issues in benchmarking the online store against the physical retail stores.
Step 2 – Identify how to benchmark the online store

Outline how you would use benchmarking to assess the performance of the online store.

ACT
Activity 6.3
Ethics, risk and analysis of performance
Introduction
This is an integrated activity that combines the topics of ethics, risk, and performance
evaluation.
This activity requires you to consider an ethical dilemma, complete analysis of an organisation’s
actual performance to date against a budget, and outline specific risks the organization is likely
to face.
The activity links to the following unit learning objectives:
Unit 1
• Identify professional (ethical) issues that may arise for Chartered Accountants in business
Unit 2
• Identify common business risks to which an organisation may be exposed
• Assess business risks for an organisation and apply strategies to treat these risks
Unit 5
• Analyse the key factors, constraints and assumptions in developing a budget or forecast
Unit 6
• Evaluate financial ratios and trends used to analyse the financial performance of an
organisation
Scenario
Dylan and Young is a privately owned clothing company with its head office located in
Melbourne, Australia. The company operates in both the retail sector (i.e. its own stores) and
non-retail sector (i.e. selling to corporates, schools and sporting organisations). In the retail
sector, Dylan and Young has speciality menswear stores located in the suburbs, rather than
the central business district (CBD) areas, in all the major cities across eastern Australia and the
North Island in New Zealand.
The business environment has changed over the last few years, forcing the company to import
most of its product range from overseas. The company now imports 90% of its products from
South East Asia, including Indonesia and Vietnam. The company’s 20Y0 budget (July 20X9
– June 20Y0) was prepared on the basis of certain assumptions about Australian and New
Zealand exchange rates. However, since the budget was prepared, both countries’ exchange
rates have deteriorated. Economic conditions in the retail sector have remained relatively strong
across both sides of the Tasman due to declining interest rates supporting consumer spending.
The largest part of Dylan and Young’s workforce is composed of sales representatives who
each have allocated regions for which they are responsible in the non-retail sector. For the
retail sector, the 20Y0 budget strategy is for the company to expand into the womenswear
retail market, by building on its long and successful history in the menswear retail market.

ACT
Recent agreements have provided the company with the opportunity to open new stores
in Perth (Australia) and Christchurch (New Zealand). These stores subsequently opened in
September 20X9. The 20Y0 budget does not include these expansion plans.
You are a Chartered Accountant (CA) working for Dylan and Young, and part of your role is to
negotiate with key suppliers to secure the best prices for the company across all regions.
All motor vehicles for Dylan and Young’s sales representatives are currently leased from a large
multinational car leasing company. This supplier agreement is due to expire in two months, and
you have recently been in discussion with another car leasing company. The current supplier
has called you and verbally offered you a deal that includes both a 10% reduction to Dylan
and Young on any offer of the monthly lease cost made by another supplier and a special deal
on your personal purchase of a second-hand, low-mileage ex-lease motor vehicle from the
current supplier.
The other major part of your role is to complete analysis on organisational progress and
performance. You have now analysed Dylan and Young’s budget for 20Y0 (i.e. the year ending
30.06.Y0) and compared it to the actual data for 20X9 (i.e. year ending 30.06.X9) and the first
three months of the 20Y0 budget (i.e. July–September 20X9). Dylan and Young’s chief executive
officer (CEO) has asked for your views on how well the company is tracking with regard to the
20Y0 budget goals. The following budget and actual data was provided:
Dylan and 20Y0 budget 20X9 actual Difference 20Y0 3-month 3-month actual
Young income (year ending (year ending actual vs 20Y0 budget
statement 30.06.Y0) 30.06.X9) (01.07.X9–30.09.X9)
items
(A$’000) (A$’000) (A$’000) (A$’000) (%)
Sales 369,800 297,582 72,218 68,948 18.6
Cost of goods 232,900 176,432 (56,468) 46,869 20.1

sold (COGS)
Gross profit 136,900 121,150 15,750 22,079 16.1
Store expenses 65,635 62,570 (3,065) 20,600 31.4
Sales 4,608 4,594 (14) 1,158 25.1

representative
expenses
Administration 43,222 42,102 (1,120) 10,480 24.2

expense
Interest expense 5,866 5,898 32 1,215 20.7
Operating profit 17,569 5,986 11,583 (11,374)
The busiest quarter is October – December with Christmas sales.
Tasks
1. Identify the key fundamental ethical principle at risk, in accordance with the International
Code of Ethics for Professional Accountants. Justify your response.
2. Analyse Dylan and Young’s 3-month actual performance against the budget.
3. Outline one (1) strategic risk and one (1) financial risk the company is likely to face in the
20Y0 budget year. For each risk, recommend an appropriate risk treatment.

ACT
Solution
1. Key fundamental ethical principle at risk: Objectivity.
Justification: Objectivity is at risk because of the personal benefit that could potentially be
obtained from the supplier offering a special deal.
2. Performance against budget

• Budget sales does not include the two new stores, so achievement to date is even weaker
than the reported 18.6% achieved of budget for the three months.
• With strong economic conditions, the expectation would be that actual sales should be
higher than budget for the equivalent period.
• Foreign exchange rate is having a negative impact on the COGS. As a high percentage of
purchases are imported, the deterioration in the exchange rates would have a significant
impact on the COGS (Budget COGS 63% of sales, whereas 3 month actuals is 68% of sales
($46,869/ $68,948)).
• The store expenses are overspent to date (31.4% of budget). This reflects two new stores that
have opened in September 20X9 and have not been included in the budget.
• Decline in interest rates has provided an opportunity to reduce interest expenses. This will
be dependent on the loan maturity dates and any rollover of these loans.
• Of major concern is the operating loss after three months, against a planned profit for the
year. Significant contributors to this result is the reduction in sales to date (achieving only
18.6% at 25% of the year (three months)). The COGS after three months represents 68% of
sales, with the budget being 63% of sales (therefore, a significant decline in the margin to
date). The conclusion is that profit will not be achieved due to declining sales and erosion of
gross margin. Seasonality is likely to be a significant influence in the comparison.
• There may be seasonal issues, such as Christmas sales, which have a significant impact on
the result. Achieving only 18.6% of sales against a budget after 3 months (25% of the way
through the year) may be a seasonal issue. A comparison to last year actual will indicate a
relevant comparison of seasonality (this is similar to the previous bullet point).
• There may be issues between the retail sector and the non-retail sector due to the product
mix change.
3. Risks
Strategic risks (one required):
i. Expansion into womenswear provides a strategic risk to the business as this is a new area
and focus. A menswear brand will not necessarily provide a link to womenswear. They are
two separate target markets.
ii. New stores opening in new cities (geographic expansion).
Treatment to reduce strategic risks:
• Understand the difference in target markets and ensure the set-out of the stores recognises
the differences.
• Ensure relevant staff in appropriate positions.
• Run campaigns that promote the new strategy.
Financial risks (one required):
i. Exchange rate fluctuations will have a significant impact on the COGS due to the large
amount of imported products.
ii. Interest rate increases (potential risk even though current environment has declining
interest rates).
Treatment to reduce financial risks:
• Apply hedging strategies on foreign currency exposures/interest costs.
• Regularly assess the benefits of sourcing from overseas suppliers.

ACT
Activity 6.4
Analysing dashboard management reports
Introduction
This activity requires you to review a management report presented in the dashboard format
and analyse the information.
• Review and analyse draft management reports.
At the end of the activity you will be able to analyse a dashboard report and determine
key trends and relationships in the information, with a view to highlighting key areas for
management’s attention.
Scenario
You are the management accountant for an operating division of XYZ Insurance (XYZ),
reporting to the CFO, Sonal Chen. XYZ is a large insurance group operating in Australia and
New Zealand, and sells insurance policies across a wide range of categories covering both
commercial and retail customers.
Within the industry it is considered to be a well-run business, and is acknowledged for
providing high-quality cover, good customer service and superior claims handling.
Insurance policies are sold in two ways:
• By insurance brokers (agents) who are paid a commission for arranging an insurance policy.
• Via the XYZ website.
The policies sold over the web are slightly different from those sold by insurance brokers, and
offer less cover for a lower premium.
The primary categories of expenditure for the business include:
• Claims paid under the insurance policies issued.
• Commissions paid to insurance brokers when they sell an XYZ policy.
• Claims handling costs, being XYZ’s staff costs incurred in managing and assessing claims.
• Costs associated with maintaining the website.
• Administration costs incurred supporting the operations of the business.

ACT
The organisation’s dashboard is as follows:
Year 4
Year 4
Year 3
Year 3
Year 2
Year 2
Year 1
Year 1
Year 4
YEAR 4
Year 3
Year 4
Year 2
Year 3
Year 1
Year 2
Year 1
Year 4
Year 3
Year 4 to Year 3
Year 44
YEAR

ACT
The Chief Information Officer (CIO) who is responsible for the IT Function of the organisation
has made you aware that certain industry data can be accessed for a price. The data is
structured, separate from that held by XYZ, and includes:
• claims data
• commissions paid to brokers
• products where volume is growing / declining
• reasons why customers switch from one insurance company to another.
• Average number of internet searches per insurance product.
The CIO has also identified the following unstructured data that is internal to the organisation
and that may be of use to you:
• Recordings of conversations between clients and the call centre. A new software package
purchased by XYZ is able to identify words or phrases which indicate that a customer
is not happy – for example ‘I have been put on hold for a long time’ or ‘this is not what
was promised’. The software is then able to classify the complaints as service related or
product related.
• A record of each hit onto the website is kept, including information on which products are
selected and the percentage of these that are turned into insurance policies.
Task
1. As part of the review of XYZ Insurance’s annual dashboard report for Year 4, Sonal has
asked you to analyse the performance of the organisation over the past four years, and
identify any interrelationships in the data contained in the dashboard report.
2. Outline whether the unstructured data identified by the CIO may be of value to XYZ,
as well as what insights could be obtained from the data.

ACT
Solution
Task 1
• The profit for Year 4 was ahead of budget due to strong revenue performance, lower than
budgeted commissions (suggesting the change in mix towards web policies was greater
than expected, or a change in the commission rate paid), and administration costs being
under budget.
• There has been significant growth in policies sold online, which has reduced the value of
commissions paid.
• Premium revenue (earned and unearned) has declined but the number of policies issued has
increased, suggesting that the value of the policies sold online might be priced at a lower
average premium (rate).
• Premium revenue (earned and unearned) has decreased, as has the amount paid as claims
(although these two figures are not directly in line with each other).
• The number of claims has also dropped; however, policy numbers are increasing.
This suggests that the level of cover offered is diminishing, which corresponds with the
increase in online policies that offer lower levels of coverage.
• The average amount per claim would have dropped significantly in Year 3 (as evidenced by
the gap between the claims’ value and the number of policies). This is likely to be linked to
the shift to web-based business (as evidenced in other graphs).
• The mix of policies sold has not shifted dramatically, with the exception of Health policies,
which have increased dramatically year on year (partially at the expense of ‘Other’).
Task 2
The industry wide data could be used to benchmark performance by XYZ. For example:
• Data trends in industry claims data could be compared to that of claims made on XYZ.
• XYZ could compare the level of commissions it pays to its brokers to that of the industry.
• XYZ could use the information regarding why people switch from one company to another
to retain its own customers as well as to attract customers from its competitors.
• XYZ could use the data on the number of internet searches per insurance product to
understand changes in customer requirements in order to respond to their needs.
XYZ could explore the following regarding the unstructured data:

• Analyse the data obtained from call centre conversations in order to identify the
characteristics of customers that are unsatisfied, determine which products cause the least
satisfaction. This may help XYZ identify the type of customers that it should be attracting
as well as the products that it should be developing or discontinuing.
• Undertake an analysis of activity in the website to see if certain products have a better
conversion rate to sales in relation to the number of hits.

ACT
The steps outline a recommended approach for successfully completing these tasks.
Step 1 – Review each pane of the dashboard

Review each pane of the dashboard to identify key issues or trends. Things to look for include:
• For variance reports, consider where further analysis and explanations are required.
• For line graphs, consider the gradient or slope of a line.
• For bar graphs, consider major changes.
Step 2 – Review common data sets within different panes

Identify the common data sets/elements (e.g. sales/revenue) that exist between the different
panes of the dashboard.
Where common data sets/elements exist, consider linkages and trends in this information.
Where relationships exist between data (e.g. between sales and variable costs), consider the
linkages and trends in this information.
Step 3 – Document your observations

Based on your findings in Steps 1 and 2, document your observations and present your analysis.
Step 4 – Compare new data to existing data

Compare the data that the CIO has described to existing data and consider how it could be used
for benchmarking or any other purposes.
Step 5 – Outline potential insights

Ouline what potential insights can be obtained from the additional data.

ACT
Activity 6.5
Evaluate pricing and performance of
an organisation
Introduction
This is an integrated activity that combines the topics of pricing, key performance indicators
(KPIs) and performance evaluation.
For this activity, you are required to explain and discuss a pricing policy, advise on and outline
a KPI, and evaluate the performance of an organisation. An appendix providing all the required
financial and non-financial information is included.
Unit 4
Unit 6
• Evaluate the financial performance of an organisation.
Unit 8
• Applying models for determining an organisation’s pricing structure.
You may wish to review the relevant section of Unit 8 before completing this activity.
It will take you approximately 45 minutes to complete this activity.
Scenario
Jacia Limited (Jacia) is a wholesaler of flowers, which it purchases from large growers and sells
on to retailers. About half of Jacia’s customers use its website to place their orders, while the
remainder place their orders through the Jacia call centre. There are three categories of customer
who use Jacia’s services: large retail stores, florists and individuals. Jacia started selling flowers
to individuals from the beginning of 20X8. Jacia’s standard mark-up on all sales is 66.67%.
You are the newly appointed chief financial officer (CFO) at Jacia, reporting to the chief
executive officer (CEO).
The following is an extract of the minutes from a recent management meeting – please read
them in conjunction with the Appendix at the end of this activity:
CEO: In 20X8, we upgraded the website with the aim of increasing the
volume of sales orders processed via the website, resulting in the
expectation that call centre costs would go down.
Sales manager (large retail stores): My clients like the new website.
Most of the large retail stores that previously used the call centre
to place orders are now using the website. The issue I have is that my
customers are the easiest to service but pay the same prices as the
florists and individual customers.
Call centre manager: I can easily cut costs by using less staff, but this
will mean that service levels will go down. The cause of the increase in
call centre costs is the disproportionate amount of time my staff spent

ACT
on processing orders from individual customers. While we do encourage
these customers to use the website, it is geared to the needs of florists
and large retailers who have a good understanding of the various
products.
Sales manager (florists): I could have told you that individuals would be
harder to service. No one listened to me when I said that we should not
sell to them. My florists were furious when we decided to do this, and
as a result many of them have been trying to source their flowers direct
from our growers. They are not happy that we charge individuals the same
prices that we charge them. Our saving grace is that the florists say
that our flowers are arriving fresher, allowing a longer shelf life and
reducing wastage.
CEO: I am concerned that the marketing expenses have increased.
Sales manager (individuals): The increase in marketing expenses in 20X8
and 20X9 is solely due to marketing our products to individuals. This has
been unavoidable because if you want to develop a new market, you
need to invest in marketing. This expenditure has paid off as sales to
individuals has increased and now exceed the marketing cost.
Purchasing manager: The flower growers are generally satisfied with
shipping flowers direct to our customers instead of sending them to us
first. We initiated this improvement to the supply chain at the beginning
of 20X9. On a separate issue: sometimes I wonder whether it is worth me
negotiating one-off special deals with the growers as that just means
that we charge our customers lower prices.
CEO: The board has requested that we continue with the policy of not
paying out a dividend in order to grow the business.
Tasks
1. Explain why the gross margin of 40% is different to the mark-up percentage of 66.67%.
2. Advise whether the call centre manager should be held responsible for the increase in call
centre costs. Outline a KPI that could be used to measure the effectiveness of the call centre.
3. Discuss whether the pricing policy of marking up all products by 66.67% is the best fit for
Jacia’s business.
4. Evaluate the performance of Jacia over the period 20X7–X9. In doing so, advise whether the
decision to sell to individuals was a good one.
Ignore any issues related to taxation. Remember to make use of the information in the appendix
on the following page.

ACT
Appendix
Income statement for the year ended 31 March

20X7 20X8 20X9 20X7 20X8 20X9
$m $m $m % of % of % of
revenue revenue revenue
Operating revenue 677 698 702 100% 100% 100%
Large retail stores 406 426 435 60% 61% 62%
Florists 271 209 190 40% 30% 27%
Individuals 63 77 0% 9% 11%
Cost of sales 406.2 418.8 421.2 60% 60% 60%
Gross profit 270.8 279.2 280.8 40% 40% 40%
Operating expenses
Marketing 104 130 133 15% 19% 19%
Call centre 29 37 42 4% 5% 6%
Website 8 12 11 1% 2% 2%
Warehousing costs 7 7 –
General and administration 8 8 8 1% 1% 1%
Total operating expenses 156 194 194 23% 28% 28%
Operating profit for year 115 85 87 17% 12% 12%
Year on year sales increase 4% 3% 1%
Growth in the flower market 3% 3% 3%

ACT
Balance sheet as at 31 March

20X7 20X8 20X9 20X7 20X8 20X9
$m $m $m % of total % of total % of total

assets assets assets
Current assets
Cash 4 89 238 1% 17% 38%
Trade receivables 56 59 57 12% 11% 9%
Inventory 63 66 – 14% 12% 0%
Total current assets 123 214 295 27% 40% 47%
Total non-current assets 325 321 327 73% 60% 53%
Total assets 448 535 622 100% 100% 100%
Current liabilities
Trade payables 45 47 48 10% 9% 8%
Other 19 18 18 4% 3% 3%
Total current liabilities 64 65 66 14% 12% 11%
Equity
Share capital 180 180 180 40% 34% 29%
Retained Income 204 289 376 46% 54% 60%
Total equity 384 469 556 86% 88% 89%
Total liabilities and 448 535 622 100% 100% 100%

shareholders' equity
Key measures 20X7 20X8 20X9
Receivables days 30.0 30.7 29.6
Inventory days 56.6 57.5 –
Payables days 40.4 41.0 41.6
Return on assets (Note 1) 25.9% 19.1% 22.6%
Note 1: For this formula cash is excluded from the total asset figure.

ACT
Solution
1. Both the gross margin and the mark-up percentage are based on gross profit. However
gross margin is calculated by dividing the gross profit by revenue, while mark-up
percentage is calculated by dividing the gross profit by the cost of goods sold.
2. The call centre manager does not have control over a key variable that causes costs in the
call centre to increase, which is the proportion of customers that place orders through
the call centre. Therefore, it would not be fair to hold the call centre manager responsible
for the increase in total call centre costs. The call centre manager could, however, be held
accountable for the cost of processing an order through the call centre.
A KPI that could be used to measure the effectiveness of the call centre is (any one (1)
of the following):
• Average cost per order processed through the call centre, reported monthly.
• Customer feedback on the effectiveness of the call centre in processing their orders,
reported monthly.
3. The current pricing policy is not the best fit for Jacia’s business for the following reasons:
• Some sales are business to business (B2B) – that is, to large retail stores and florists.
Other sales are to end users – that is, the individual customers. Jacia is undermining
their large retailer and florist customers by charging individual customers the same
price as the large retail stores and florists. This has resulted in florists attempting to
bypass Jacia and going direct to the growers for their supplies, creating a key risk to
the business.
• If the purchasing manager negotiates a discount with the flower growers, then Jacia’s
profit is reduced. This is because using a standard mark-up on a lower cost would mean
that the price to customers is automatically lowered, reducing profit.
4. Market share: While in 20X7 the growth in sales was higher than the growth in the flower
market, this has reversed in 20X9. This means that, in 20X9, Jacia has lost market share.
This could be due to florists purchasing flowers direct from the growers.
Cost of sales: This has remained consistent at 60% of revenue. Similarly, gross profit has
remained consistent at 40% of revenue. The reason for this is that the current pricing policy
requires a standard mark-up to be applied to all sales.
Sales to large retail stores: This has increased from 60% of total revenue to 62% of total
revenue. This could be as a result of either: the growth in the flower market; a more efficient
ordering process through the website; or fresher flowers being delivered following the
improvement to the supply chain.
Sales to florists have declined from 40% of total sales in 20X7 to 27% of total sales in 20X9.
This is probably a consequence of selling direct to individuals.
Decision to sell to individuals:
• The extra gross profit earned from individuals ($25 million in 20X8 and $31 million
in 20X9) hardly covers the extra marketing cost incurred in marketing to individuals.
• It appears that selling to individuals has resulted in Jacia losing a higher volume of
revenue to florists – that is, the net impact on revenue is negative.
• Call centre costs have increased in 20X8 and 20X9, while it would have been expected
that they would have reduced as a result of more sales being processed through the
improved website. The reason for this increase is due to individual customers placing
their orders through the call centre.
• Based on the results above, the decision to sell direct to individuals was not a good one.

ACT
Website costs: These costs have increased in 20X8 and 20X9 as a result of the upgrade of the
website to encourage customers to place their orders there.
Warehousing costs: These costs have reduced in 20X9 as a result of the improvement to
the value chain whereby flowers are despatched direct from the growers to customers.
Operating profit: While gross margin has remained consistent at 40%, operating profit
has not – that is, it has reduced from 17% to 12%. The key reason for the decrease in the
operating profit in 20X8 and 20X9 is that the marketing and call centre costs have increased.
Cash position: The cash position has improved as a result of moving to zero inventory
in 20X9 by having flowers shipped direct from growers to customers. The cash position
has also improved as profits have been retained in the business/have not been paid out
as dividends.
Return on assets: This has decreased from 25.9% in 20X7 to 19.1% in 20X8, largely as a
result of increased marketing and call centre costs. The reason for the increase in the return
on assets in 20X9 is because, although operating income has remained at a similar level, the
value of assets has decreased due to Jacia no longer holding inventory.
Dividends: While the board has requested that dividends not be paid, in order to grow
the business, in reality the profits have not been reinvested in the business but have been
retained as cash.

ACT
Unit 7: Analysing actual performance II
Activity 7.1
Applying ROI using the DuPont method
Introduction
This activity uses the DuPont method to analyse the ROI of an organisation, with a view to
understanding the difference between actual and expected levels of performance.
• Apply return on investment (ROI) as a management decision-making tool.
Scenario
You are the group head of management accounting for Accutime. Graham Anderson, the chief
financial officer (CFO), has asked you to assess the financial performance of Accutime based
on ROI.
Tasks
To complete this activity you will need to carry out the following tasks:
1. Calculate Accutime’s ROI for 2018 and 2017.
2. Use the DuPont method to explain the key reason for the variance in performance between
the two years.
Note: when completing the above two tasks ignore Accutime’s share in its joint venture.
maaf12107_act_01

ACT
Solution
Task 1
ROI excluding the joint venture:
ROI for 2018 is 3.92%.
ROI for 2017 is 5.72%.
ROI including the joint venture:
ROI for 2018 is 4.71%
ROI for 2017 is 5.15%
Task 2
Based on the DuPont method, the key reason for the variance in performance between the years
relates to the decline in the profit margin (efficiency ratio) of the business.
The steps outline a recommended approach for successfully completing the tasks. Please note
that all amounts are in thousands of dollars.
Task 1
Step 1 – Determine operating income (EBIT)
EBIT values (from the Accutime case study) are:
• 2018 – $11,135.
• 2017 – $11,656.
Step 2 – Determine investment (total assets value)

Investment values (from the Accutime case study) are:
• 2018 – $284,084 (322,912 - 38,828 being total assets less interest in joint venture)
• 2017 – $203, 798 (233,618 - 29,820)
Note: Joint venture assets are excluded from total assets so that the numerator and denominator
are consistent in the ROI calculation, as the income statement for Accutime shows the operating
profit before financing costs, excluding share of joint venture profits. Consistency in calculations
is key to ensuring that subsequent analysis is useful.

ACT
Step 3 – Calculate ROI for 2018 and 2017

Operating income
ROI = Investment
ROI for 2018 is 3.92%, calculated as follows:
Operating income before financing costs

ROI = Total assets value
$11, 135
ROI = $284, 084
ROI = 3.92%
ROI for 2017 is 5.72%, calculated as follows:
Operating income before financing costs

ROI = Total assets value
$11, 656
ROI = $203, 798
ROI = 5.72%
Alternative Step 3: Calculate ROI including the joint venture

2018 2017
EBIT 11,135 11,656
Plus share of joint venture profits 4,086 387
EBIT including joint venture 15,221 12,043
Total Assets ($’000) 322,912 233,618
ROI (including joint venture) 4.71% 5.15%

ACT
Task 2
Step 1 – Determine absolute variation in ROI performance
The level of ROI performance has fallen from 5.72% in 2017 to 3.92% in 2018. This is a fall of 1.8%.
Step 2 – Break down the ROI calculations into efficiency and productivity
components
Using the DuPont method, separate your ROI calculations into their respective efficiency and
productivity components.
Formula 2018 2017
Operating income $11,135 ÷ $227,177 = 4.9015% $11,656 ÷ $167,366 = 6.9644%

Efficiency = Sales
Sales $227,177 ÷ $284,084 = 0.7997 $167,366 ÷ $203,798 = 0.8212

Productivity = Investment times times
ROI = Efficiency × Productivity 4.9015% × 0.7997 = 3.92% 6.9644% × 0.8212 = 5.72%
Step 3 – Interpret the results

Based on the above calculations, the profit margin (efficiency ratio) of the business has clearly
declined year on year. Further analysis of Accutime’s financials reveals the decline has
been driven by a drop of 4.97% in the gross margin (from 38.13% in 2017 to 33.16% in 2018).
Further investigation would be required to establish the cause of this fall, which could be due
to a reduction in selling prices per unit, an increase in the cost of goods sold, or a change in the
sales mix.
Extract from Accutime’s Income statement 30 June 2018 30 June 2017

$’000 $’000
Gross profit 75,323 63,816
Add: Other operating income 3,030 76
Less: Operating expenses 53,980 57,155
Depreciation 9,169 7,620
Intangibles amortisation 1,783 2,029
Operating trading gain/(loss) 13,421 (2,912)
Other gains/(losses) (2,286) 14,568
Operating profit before financing costs (EBIT) 11,135 11,656
Based on the financial results, it is also apparent that operating income due to trading increased
in 2018, and that other gains/(losses) went from a gain of $14,568 in 2017 to a loss of $2,286.
Again, the details of these movements would need further investigation.
The efficiency ratio is the key driver of the ROI, as the deterioration in the productivity ratio
has been very minor. The fact that the productivity ratio is almost consistent year on year is
somewhat surprising, given that Accutime acquired BAC Technologies in December 2017.
The increase in Accutime’s assets has translated to a proportionate increase in revenue, resulting
in the small adjustment to the productivity ratio.

ACT
Activity 7.2
Performing an EVA® calculation
Introduction
The ability to perform and interpret an EVA® calculation is an important skill for management
accountants and will aid them in providing advice to management on how to improve an
organisation’s performance.
• Apply EVA® as a management decision-making tool.
At the end of the activity you will be able to perform an EVA® calculation, analyse the results
and use that analysis to identify ways to improve performance.
Scenario
You are the group head of management accounting for Accutime. Graham Anderson, the CFO,
has asked you to review the financial performance of Accutime and consider whether the
company could use EVA® to assess the performance of each of the geographical business units.
For the purposes of this activity, assume that Accutime uses a weighted average cost of capital
(WACC) of 10.7% and that the effective company tax rate is 30%.
Tasks
1. Review the financial performance of Accutime’s operations by:
(a) Calculating EVA® for 2018 and 2017.
(b) Explaining the variance in EVA® performance between the two years.
(c) Identifying how Accutime’s EVA® could be improved in the future.
2. Assess whether Accutime should use EVA® to measure the financial performance of each
of its geographical business units by:
(a) Explaining whether this proposal is practical and any key issues that may need to be
considered.
(b) Outlining the implications of using a WACC specific to each of the business units.

ACT
Solution
Task 1
(a) EVA® 2018: ($18,375,000); EVA® 2017: ($13,675,000)
(b) Investments in 2018 have resulted in below-WACC returns, causing a further reduction
in shareholder value from 2017.
(c) Accutime needs to improve the return on its investments, in particular, trade and other
receivables and cash. The company should also focus on the delivery of increased operating
profits.
Task 2
(a) Given that the business units operate separately (effectively as investment centres), EVA®
would be considered an appropriate tool for assessing their individual performance. A key
issue to be considered before making a final decision is the impact of transfer pricing
policies on financial results.
(b) Using a WACC specific to each of the business units would be appropriate as it would allow
for the differing risk profiles associated with each of the business units in the calculation.
The steps outline a recommended approach for successfully completing the tasks.
Task 1
Step 1 – Review the core content to determine EVA® components
EVA® = Net operating profit after tax – [WACC × (total assets – current liabilities)]
Step 2 – Review the Accutime case study to determine input values

Value 2018 2017
Net profit after tax ($'000) 10,591 6,624
Plus interest expense 625 2,778
Less tax on interest expense (188) (833)
Net Operating profit after tax 11,029 8,569
Total Assets ($'000) 322,912 233,618
Current liabilities 49,052 36,631
Less: overdraft (941) (8,296)
Less: borrowings (2,605)
Non-interest bearing current liabilities 48,111 25,730
WACC 10.7% 10.7%

ACT
Step 3 – Input the Accutime data

For 2018 ($’000):
EVA® = $11,029 – [10.7% × ($322,912 – $48,111)]

= ($18,375)
For 2017 ($’000):
EVA® = $8,569 – [10.7% × ($233,618 – $25,730)]

= ($13,675)
Note: As mentioned in the CSG, organisations adjust the components of EVA® to reflect what
they are trying to achieve when assessing performance. An alternative approach to the one
above would be to exclude the share of joint venture profits as well as the interest in joint
venture when calculating EVA®.
Step 4 – Analyse the reasons for changes to EVA®

EVA® in both 2018 and 2017 is negative, meaning that shareholder value has been eroded.
EVA® value has fallen further in 2018, and this is due to an increase in investments (up
$89,294,000) at a return level less than WACC. Net profit after tax increases by $3,967,000, and
net operating profit after tax increases by $2,460,000, which is a return of 2.75% on the increase
in investments. This is less than the WACC of 10.7%, so investors are not earning their required
rate on this additional investment and therefore leads to a further fall in the value of EVA®.
The WACC has been kept constant across the time period, and so does not impact the results.
Step 5 – Make recommendations to improve EVA®

Accutime has made some recent investments in new operating entities and joint ventures.
This has increased the cost base of the business; however, some of the investments are yet
to provide a full year’s contribution to Accutime’s profits. On a like-for-like basis in 2019,
EVA® should improve, as although the capital base would remain unchanged, there should be
a growth in profits. Therefore, focusing on the delivery of increased operating profits from the
existing business units would help improve EVA®.
There has also been an increase in cash held in 2018 to $17.3 million. Investment of this cash into
investments yielding more than 10.7% would also help improve EVA®.
Trade and other receivables have increased by 49.9%. Given that revenue has only increased
by 35.7%, the return on this asset needs to be improved or the value of capital invested in trade
and other receivables reduced.

ACT
Task 2
Step 1 – Determine the independence of the business units
As the business units operate separately with their own identifiable assets, EVA® would be an
appropriate tool to use to assess the financial performance of each of the geographical units.
However, they do transfer a significant amount of product between themselves. If the transfer
price used is fair and equitable, the validity of the EVA® calculation is not impaired. However,
if the transfer price is not market-based, it would result in the transfer of margin from one
business unit to another, and therefore impact assessment of financial performance for both
business units.
Step 2 – Assess the impact of using business unit-specific WACCs

Using a business unit-specific WACC in each of the EVA® calculations would improve the
quality of the analysis results. This is because they would reflect the specific risk attached to the
capital structure funding each operation. Some business units might be more debt-laden, and
therefore the cost of the investment should be adjusted accordingly.
Using a business unit-specific WACC would therefore increase understanding of the
contribution of each business unit and its investment in the facilities.
While a single WACC would make the process simpler to implement and monitor, it would
reduce the accuracy, and hence validity, of the evaluation.

ACT
Activity 7.3
Comparing ROI and EVA® results
Introduction
This activity requires you to review the results of previous analysis to calculate ROI and EVA®,
and then compare the results in order to understand the difference between them as tools
of analysis.
• Compare the results of ROI and EVA® analyses.
At the end of this activity you will be able to understand the difference between ROI and EVA®
as analytical tools. You should complete Activities 7.1 and 7.2 prior to attempting this activity.
Scenario
You are a management accountant reporting to Graham Anderson, CFO at Accutime Limited
(Accutime). Accutime’s management is reviewing which is the best tool to assess its financial
performance at a group, as well as an international, business unit level. The options under
consideration are ROI or EVA®.
Graham has tasked you with investigating the choices and has supplied you with the following
information for Accutime, based on previously undertaken analysis:
ROI and EVA® results for 2018 and 2017 (including the joint venture)
2018 2017
ROI 4.71% 5.15%
EVA® ($’000) ($18,375) ($13,675)
Tasks
Graham has asked you to assess the financial performance of Accutime. You should have
already completed ROI and EVA® calculations (refer to Activities 7.1 and 7.2 respectively) and
analysed their results.
1. Determine which measure (ROI or EVA®) would provide Accutime’s management with the
better tool to assess performance at the consolidated group level. Justify your response.
2. Outline which measure (ROI or EVA®) would provide Accutime’s management with the
better tool to assess the financial performance of its international business units. Justify
your response.

ACT
Solution
Task 1
ROI for 2018 is 4.71%, and for 2017 it was 5.15%. As the EVA from Activity 7.2 includes the joint
venture, for consistency the ROI that includes the joint ventures has been used.
The ROI analysis suggests that 2017 was the better performing year. Based on Activity 7.1, the
key reason for this fall in performance in 2018 was linked to a decline in the level of efficiency.
The EVA® for 2018 was ($18,375,000), while for 2017 it was ($13,675,000).
The EVA® analysis suggests that 2017 was the better performing year. Based on Activity 7.2,
the key reason for this fall in performance was linked to the value of a number of investments,
including an increase in the levels of inventory, during 2018.
Both results confirm that the business is underperforming – with low ROIs and negative EVA®
– with both measures providing a consistent view that performance has declined from 2017
to 2018.
The decline in the gross profit margin of the business in 2018 drove the decline in ROI in that
year, suggesting that the investments made had little impact on the productivity component of
the calculation.
The EVA® calculation suggests that the investments made late in 2017 and in 2018 have not yet
started to provide the return to shareholders that was envisaged. Given that Accutime is an
ASX-listed entity with an objective to enhance shareholder wealth, EVA® as a measure clearly
aligns with this.
Using EVA® allows management to clearly see whether investment decisions made have
enhanced or reduced shareholder value in absolute terms. ROI simply provides a relative
measure of performance, without indicating the true level of underperformance.
It would, therefore, be recommended that Accutime use EVA® to assess financial performance at
the consolidated group level.
Task 2
ROI will provide a relative measure of performance that would allow comparisons of financial
performance between the business units to be made without them being distorted by the size of
the respective business units.
The business units are quite different, including manufacturing facilities, marketing and
technical support offices, and joint ventures. However, Accutime has the ability to assess the
investment made in each location, and therefore can use EVA® to assess whether it is generating
a return for shareholders.
EVA does take into account the level of risk associated with each by incorporating the expected
level of return or the cost of capital to be applied if EVA® is to be used to assess the individual
business units. The limitation of EVA is that it does not take into account the relative size of
the respective business units and can therefore provided distorted results when comparing the
individual business units to each other.
Given the limitations of both measures, it is recommended that ROI and EVA® be used in
combination to assess the financial performance of Accutime’s international business units.
For both measures to be used effectively, Graham Anderson will need to ensure that
all stakeholders understand the meaning and benefit of each measure so that they can
appropriately and correctly assess the information in order to reach suitable conclusions and
make sound decisions.

ACT
The steps outline a recommended approach for successfully completing the tasks.
Task 1
Step 1 – Review the results
Review the results for Activities 7.1 and 7.2.
Step 2 – Compare and contrast results

Compare and contrast the results of Accutime’s ROI and EVA® performance for 2018 and 2017.
Step 3 – Consider the limitations

Consider the limitations of ROI and EVA® based on information contained in the core content
for this unit.
Step 4 – Make a recommendation

Using the information you have gained, make a recommendation as to the most appropriate
tool to use to assess the financial performance of Accutime at the group level.
Task 2
Step 1 – Review the Accutime case study
Review the Accutime case study and determine the organisational structure for the business.
Step 2 – Consider the limitations

Consider the limitations of ROI and EVA® based on information contained in the core content
for this unit.

Make a recommendation as to the most appropriate tool to use to assess the financial
performance of Accutime’s various international business units.

ACT
Unit 8: Pricing policy
Activity 8.1
Calculating alternative pricing methods
Introduction
This activity requires you to use alternative pricing methods for a food and beverage outlet.
• Evaluate both the qualitative and quantitative factors impacting a pricing decision.
• Apply models for determining an organisation’s pricing structure.
At the end of this activity you will be able to produce various pricing options and make
a recommendation about an organisation’s pricing.
Scenario
You are a senior accountant at EBA Financial Services, and one of your clients, Supreme Coffee,
is looking to open a new coffee shop in a busy retail area. The owner (Jumbo Hiro) of Supreme
Coffee has asked for your help in setting prices.
Jumbo has informed you that he would like to explore various pricing options using Supreme
Coffee’s espresso range as an example. He has collected some competitor data and other related
information to assist you.
The new shop lease allows Supreme Coffee to be open seven days a week.
Supreme Coffee’s applicable cost information for its espresso range of products is as follows:
Small Medium Large

$ $ $
Variable costs per cup
Materials (coffee, milk, cup, etc.) 1.00 1.10 1.30
Labour 0.45 0.45 0.45
Utilities (electricity, water, etc.) 0.05 0.05 0.05
Coffee variable overheads 0.10 0.15 0.20
Other costs
Annual espresso coffee fixed overheads 25,000
General shop overheads 200,000

maaf12108_act_01

ACT
Current competitor pricing (excluding GST) was found to be as follows:
Page 8-2
Competitor Glorious Jeans Michael’s Patties CupCake King Rancour’s Café Deluxe
Coffee size Small Medium Large Regular Large Super Small Medium Large Diminutive Media Expansive
$ $ $ $ $ $ $ $ $ $ $ $
Filtered 2.50 3.00 3.50 2.25 2.50 3.00 2.25 2.50 3.00 3.00 3.50 4.00
Short black 2.50 – – 2.50 – – 2.50 – – 4.00 – –
Long black – 3.50 – – 3.00 – – 3.00 – – 4.50 –

Espresso 3.75 4.25 4.75 3.50 3.80 4.20 3.50 3.80 4.20 4.00 4.50 5.00
Mocha 4.00 4.50 5.00 3.75 4.00 4.50 3.75 4.00 4.50 4.50 5.00 5.50
Hot chocolate 3.75 4.25 4.75 3.50 3.80 4.20 3.50 3.80 4.20 4.00 4.50 5.00
Extras
Soy milk 0.50 0.30 0.30 0.75
Extra shot 1.00 1.00 1.00 1.25
Dine-in 1.00
Quality rating    

Activities – Unit 8
ACT
Tasks
For this activity you are required to prepare an analysis of various pricing alternatives for
Supreme Coffee (ignoring GST).
You have been asked to complete the following tasks:
1. Determine appropriate pricing levels for Supreme Coffee’s range of products taking into
account existing competitor prices, and assuming that your client expects the new coffee
shop to be a 4–4.5 star business (without reference to costs).
2. Determine appropriate pricing levels using variable costs for espresso coffee only, assuming
a 140% mark-up.
3. Determine appropriate pricing levels using full cost for espresso coffee only, assuming a
100% mark-up and expected daily sales of 300 cups of espresso coffee. Espresso sales are
expected to represent 15% of Supreme Coffee’s revenue.
4. Given the following additional information for large espressos, calculate the price at which
Supreme Coffee should sell its large espresso.
Price $ Expected daily sales
3.50 200
3.75 175
4.00 150
4.50 100
5.00 75
5.25 50
5. Outline factors other than margin (gross and/or net) that Supreme Coffee would need to
take into consideration before deciding on the price of its large espresso coffee.

ACT
Solution
The solution to each task (regarding the various pricing alternatives for Supreme Coffee)
is provided in the recommended approach below.
Task 1 – Determine appropriate pricing levels using

competitor pricing
The key to competitor pricing is the star rating for Supreme Coffee. Given that Supreme Coffee
expects to be rated between Glorious Jeans (3.5 stars) and Rancour’s Café Deluxe (5 stars), the
pricing should reflect this. By pricing closer to Glorious Jeans and providing a superior quality
coffee and service, Supreme Coffee can aim to attract customers away from Glorious Jeans.
One possible structure taking this into account follows:
Coffee size Small Medium Large

$ $ $
Filtered 2.75 3.25 3.50
Short black 2.75 – –
Long black – 3.50 –
Espresso 3.75 4.25 4.75
Mocha 4.00 4.50 5.00
Hot chocolate 3.75 4.25 4.75
Extras
Soy milk 0.50
Extra shot 1.00
Dine-in – – –
Quality rating 
This structure has most coffee lines at the same price as Glorious Jeans, with marginally higher
prices for small and medium filtered coffee.
Key steps to completing this task include:
• Reviewing prices of all competitors.
• Identifying competitors with a similar quality rating to Supreme Coffee.
• Determining a pricing structure comparable to competitors with a similar quality offering
to Supreme Coffee.
Note: Answers that have different prices to the ones above would be acceptable, as long as they are equal
to or higher than those of Glorious Jeans, and lower than those of Rancour’s Cafe Deluxe.

ACT
Task 2 – Determine appropriate pricing levels using variable costs

Use variable costing to determine the price of an espresso coffee as below:
Small Medium Large

$ $ $
Labour 0.45 0.45 0.45
Total variable costs 1.60 1.75 2.00
Mark-up (140%) 2.24 2.45 2.80
Selling price 3.84 4.20 4.80

• Calculating the total variable costs for each size of espresso.
• Calculating the mark-up based on the variable costs.
• Calculating the selling price based on the variable costs plus mark-up.
Task 3 – Determine appropriate pricing levels using full costs

Use full costing to determine the appropriate price of an espresso coffee, as below:
Small Medium Large

$ $ $
Labour 0.45 0.45 0.45
Annual espresso coffee fixed overheads 0.23 0.23 0.23
General shop overheads 0.27 0.27 0.27
Total full cost 2.10 2.25 2.50
Mark-up (100%) 2.10 2.25 2.50
Selling price 4.20 4.50 5.00
In the full cost calculation, annual espresso coffee fixed overheads and general shop overheads
should be allocated as follows:
Annual espresso coffee fixed overheads would be:
$25,000 ÷ 365 days ÷ 300 coffees per day = $0.23.
General shop overheads would be:
$200,000 × 15% ÷ 365 days ÷ 300 coffees per day = $0.27.
• Starting with the total variable cost per size calculated in Task 2.
• Calculating the annual espresso fixed overheads to be applied per unit.
• Calculating the general shop overheads to be applied per unit.
• Calculating the full cost per unit (variable costs, plus annual espresso fixed overheads plus
other shop overheads).

ACT
• Calculating the mark-up based on the full cost.
• Calculating the selling price based on full cost plus mark-up.
Task 4 – Calculate the price for a large espresso

Based on the calculations in the table below, the large espresso should be priced at $3.75
per cup. This is because it has the highest total daily contribution margin. This has been
calculated using the variable cost of $2 calculated in Task 2 to determine a contribution margin
per cup for each option, which is then multiplied by the expected sales volume to get a total
contribution margin.
Large espresso coffee sales analysis
Selling price $3.50 $3.75 $4.00 $4.50 $5.00 $5.25
Variable cost $2.00 $2.00 $2.00 $2.00 $2.00 $2.00
Contribution margin $1.50 $1.75 $2.00 $2.50 $3.00 $3.25
Expected sales units per day 200 175 150 100 75 50
Total daily contribution margin $300.00 $306.25 $300.00 $250.00 $225.00 $162.50

• Starting with the variable cost per size calculated in Task 2.
• Calculating the unit contribution margin at each price point.
• Multiplying the unit contribution margin for each price point by the expected daily sales for
that price point.
• Determining the price point that provides the highest total contribution margin.
Task 5 – Other factors to consider prior to making a final decision

Other than margin, factors that Supreme Coffee would need to take into account before setting
the price for its large espresso include:
• The potential reaction and response of competitors to its pricing strategy.
• How Supreme Coffee’s pricing strategy and offerings would help to draw customers away
from existing competitors.
• How the quality of Supreme Coffee’s offering is reflected by the pricing.
• Whether a low price point for the large espresso would cause more people to upgrade from
small/medium sizes, and how this would impact on overall profitability.

• Reviewing the CSG content, and consider key issues with determining an organisation’s
pricing in a competitive environment.
• Considering Supreme Coffee’s environment, how its pricing impacts the delivery of its
strategy and how existing competitors are likely to react to its entry into their market.

ACT
Activity 8.2
Price discounting
Introduction
This activity requires you to apply price discounting in a manufacturing environment.
• Evaluate both the qualitative and quantitative factors impacting a pricing decision.
• Apply discounting models and assess their impact on an organisation’s profits.
At the end of this activity you will be able to assess the impact of discounting on the
profitability of an organisation and determine the most appropriate pricing policy.
Scenario
You are a management accountant at Accutime and have been asked by Graham Anderson,
the chief financial officer (CFO), for advice relating to the release of its Version 5 temperature
compensated crystal oscillator (TCXOv5) in approximately six months.
More details are provided below:
1. Version 4 (TCXOv4) stock on hand

Accutime currently has 450,000 units of Version 4 (TCXOv4) on hand, which equates to
approximately eight months’ worth of stock at existing prices. It is expected that with the
launch of the TCXOv5, any remaining stock of the TCXOv4 will need to be written off within
a month of the launch.
2. Pricing strategy for Version 4 (TCXOv4)

The TCXOv4 normally sells for $0.60 and has a margin of 30%. The sales team are considering
how best to clear stock prior to the release of the TCXOv5, and has provided a table so that you
can advise Graham of the most appropriate pricing strategy.
Option Discount Expected sales Expected wastage

level period (units)
1 0% 7 months 75,000
2 5% 7 months 40,000
3 7.5% 7 months 20,000
4 10% 7 months 0
5 15% 6 months 0

ACT
Tasks
For this activity you are required to provide Graham with recommendations regarding the
pricing options for the TCXOv4.
1. Determine the gross profit Accutime would make under each option, and recommend
the preferred option.
2. Outline other factors that could influence your recommendation.
3. If the research and development (R&D) team had a history of delivering projects one
to two months late, explain how your answer would change.

ACT
Solution
The solution to each task in relation to the pricing option for the TCXOv4 is provided in the
recommended approach below.
Task 1 – Determine the gross profit for each option

Accutime currently has 450,000 units of the TCXOv4 in stock. It is expected that the new model
(TCXOv5) will be launched in six months time.
Option Selling Cost/ Units Revenue Cost of Gross

price unit sold 450,000 profit
units
$ $ $ $ $ $
1 0.60 0.42 375,000 225,000 189,000 36,000
2 0.57 0.42 410,000 233,700 189,000 44,700
3 0.56 0.42 430,000 238,650 189,000 49,650
4 0.54 0.42 450,000 243,000 189,000 54,000
5 0.51 0.42 450,000 229,500 189,000 40,500
The total gross profit for each option needs to consider the total margin on each sale (selling
price less cost per unit), less the cost of any unsold units.
Based on the above calculations, Option 4 provides the highest total profit after write-offs.
• For each option, calculate gross profit per unit (selling price less cost). Cost = $0.60 × 70%.
• For each option, calculate expected unit sales. (450,000 units less expected wastage).
• For each option, calculate expected revenue and gross profit before wastage.
• For each option, calculate expected wastage in units and the cost of wastage.
• For each unit, calculate net gross profit after wastage.
Note that an alternative approach would be to choose the optimum option based only on
revenue generated. This would be on the basis that the stock is redundant and therefore not a
relevant cost. Both approaches would result in the same option being chosen (option 4) because
when calculating gross profit the combined COGS and ‘costs written off’ for each option would
be the same.

ACT
Task 2 – Outline other factors that could influence your

recommendation
Other factors to be considered when determining which option you would recommend include:
• Whether the new version will be delivered on time.
• Whether demand is relatively even or is seasonally affected.
• Whether adopting Option 5 and selling out early could result in extra sales of the TCXOv5,
which would increase total sales and provide additional margin/profit.
• The expected selling price and margin of the TCXOv5.
• Whether the increased sales volume of the TCXOv4 would slow the uptake of the TCXOv5.
• The current stock levels of the TCXOv4 held by customers, and how they plan to run down
their stocks.
• What communication has occurred with customers who purchase the TCXOv4, and what
are they doing to move/migrate their products over to the TCXOv5?
• The estimated carrying costs of inventory. While profit is less under Option 5, the TCXOv4
would sell out one month earlier, and thus the carrying cost of inventory could impact
overall profits.
• The impact of stock-outs on customers, along with the impact on the reputation of Accutime
and its brand image. Will customers find substitutes before the TCXOv5 can be released?

• Reviewing the CSG content to determine what types of issues need to be considered when
setting a pricing strategy
• Reviewing the background and determining key issues to be considered in selecting
a pricing option.
Task 3 – Consider how late delivery of the new version could affect
your recommendation
If the R&D team has a history of delivering projects one to two months late, then Option
1 would be the preferred option. With an additional month of sales, Accutime could sell
approximately 53,571 additional units (375,000 ÷ 7 months).
On this basis, the revised net gross profits after wastage would be:
Option Selling Cost Gross Gross Revised Revised Total Units Costs Net
price per unit profit profit units revenue gross wasted written gross
per unit per unit margin sold profit off profit
per unit before after
wastage wastage
$ $ $ % $ $ $ $
1 0.600 0.42 0.180 30.00 428,571 257,143 77,143 21,429 9,000 68,143
2 0.570 0.42 0.150 26.32 450,000 256,500 67,500 0 0 67,500
3 0.555 0.42 0.135 24.32 450,000 249,750 60,750 0 0 60,750

• For each option, calculate gross profit per unit (selling price less cost).
• For each option, calculate expected unit sales.
• For each option, calculate expected revenue and gross profit before wastage.
• For each option, calculate expected wastage units and cost of wastage.
• For each unit, calculate net gross profit after wastage.

ACT
Activity 8.3
Target pricing
Introduction
This activity requires you to demonstrate your understanding of target pricing.
• Demonstrate how target sales pricing can be used to maximise an organisation’s profits.
At the end of this activity you will be able to demonstrate how target sales pricing is used
to manage an organisation’s launch of a new product.
Scenario
You are a management accountant who has recently commenced work with TechCentra, an
Australian-based technology organisation looking to make and distribute a new tablet PC.
Based on your research, you have discovered that while the Lime computer tablet is the
dominant player in the market, there are a number of other manufacturers who are seeking
to cash in on the shift away from desktops and notebook computers to tablets. The table shows
the retail price range (excluding GST) of the various brands of tablet computers currently
on the market:
Manufacturer Retail price range

$
Lime 550–750
Pacer 550–750
Sus 700–850
Blueberry 550–800
BC 550–700
Slovon 525–650
Oxford 550–750
TechCentra is planning to offer three versions of its new tablet, called the Plate, with the
following features:
Feature Small Plate Round Plate Square Plate
Storage 64GB 128GB 256GB
Screen size 25cm 30cm 40cm
Wi-Fi   
4G  
Forward camera   

ACT
Feature Small Plate Round Plate Square Plate
Rear camera  
Telephone capable 
DVD slot 
Serial port 
USB port   
External keyboard 
Battery life 10 hours 15 hours 25 hours
Office apps 
TechCentra currently plans to manufacture all Plate tablets in Australia, with a number of
components sourced overseas.
Details for each model are as follows:
Details Small Plate Round Plate Square Plate
Retail price (excluding GST) $550 $650 $850
Materials $200 $275 $400
Labour $50 $50 $50
Production overheads $75 $75 $95
Distribution costs $25 $25 $25
Other selling costs $50 $50 $75
Expected gross margin 40% 40% 40%
Product life 2 years 2 years 3 years
Expected unit sales 200,000 150,000 80,000
R&D costs already committed $20,000,000 $20,000,000 $15,000,000
All sales are to be made direct to the consumer, either via the web or telephone, with goods to
be couriered to the consumer.
TechCentra has set its target prices based on the market conditions.
Tasks
For this activity you are required to advise TechCentra on the pricing of its new products.
1. Determine which of TechCentra’s new Plate tablets will meet its required gross
margin targets.
2. Based on your answers to Task 1, assess TechCentra’s gross margin target and how it could
impact TechCentra going forward.
3. Given that pricing is fixed due to market conditions, identify the options available to
TechCentra to achieve its desired financial goals.

ACT
Solution
The solution to each task (advising TechCentra on the pricing of its new products) is provided
in the recommended approach below.
Task 1 – Determine gross profit margins

While this may be a relatively easy calculation, the key is the treatment of selling and
distribution costs. Gross margin is based on cost of goods sold (COGS) – selling and distribution
costs do not form part of COGS.
Based on the results in the table, neither the Round Plate nor the Square Plate meet the required
gross margin targets.
Gross margin per unit per model
Small Plate Round Plate Square Plate
Retail price $550 $650 $850
COGS
Materials $200 $275 $400
Labour $50 $50 $50
Overheads $75 $75 $95
Total COGS $325 $400 $545
Gross margin $225 $250 $305
Gross profit margin percentage 40.91% 38.46% 35.88%

• Calculating COGS per unit for each model of tablet. Note that COGS does not include
selling and distribution costs.
• Calculating the dollar value and percentage of gross margin per unit for each model.
• Comparing the calculated gross margin percentage against TechCentra’s benchmark level
of 40%.

ACT
Task 2 – Assessment of impact of gross margin target

Small plate achieves the gross margin target while Square Plate and Round Plate do not. It is
clear that changes must therefore be made to the Square Plate and Round Plate tablets.
• Reviewing calculations from Task 1.
• Highlighting models that do not meet the benchmark requirements of TechCentra.
Task 3 – Options to achieve financial goals

Based on the results achieved, the key issue relates to the Square Plate, as it does not meet the
gross margin target.
Given the cost breakdown of other products, the main areas that should be looked at include:
• Material costs, which represent 47.06% of the retail price, compared to 42.31% for the Round
Plate and 36.36% for the Small Plate. A reduction to 42% would decrease costs by $43,
or 5.1% of $850.
• Overheads, which are $20 higher than either the Small or Round Plates, despite labour costs
being the same. The reason for this difference needs to be determined to see if it relates to
appropriate costs or value-adding activities. If this difference can be reduced to a figure
closer to that of other products – e.g. $82.50 – then that saving (in this example, $12.50)
would help improve the gross margin.
• Other selling costs are $25 higher than the Small or Round Plates. What is the cause of
these additional costs and are they value-adding? If this difference can be reduced by 50%,
TechCentra would save $12.50 per unit.
The Round Plate also does not meet the gross margin target. The material cost of the Round
Plate (42.3% of retail price) is clearly higher than that of the Small Plate (36.4% of retail price): if
the material cost for the Round Plate was reduced from 42.31% of the retail price to say 40% of
the retail price, then the expected gross margin would be achieved.
All options outlined above would reduce the cost per unit for the Square Plate design by a total
of $68 ($43.00 + $12.50 + $12.50). The first two options would result in a revised gross margin of
$360.50 which means that the new gross margin (42.41%) would exceed the target. Whilst the
third option does not impact upon gross margin, it would improve Square Plates profitability
by $12.50 per unit.
• Identify any models that do not meet either of the benchmark performance levels of
TechCentra.
• Compare aspects of financials (revenue and costs) between the different models and
highlight key areas of difference.
• For each area of difference determine if there is an adequate explanation for the difference.
If this is not the case, consider if performance may be improved in order to improve the
overall financial performance of the model in the particular area.
• Determine whether employing all opportunities to reduce costs would allow for the model
to achieve the desired financial performance levels.

ACT
Unit 9: Cost management I
Activity 9.1
Life-cycle costing
Introduction
Life-cycle costing is a process to determine the lifetime financial return on an investment
(including new products), with the objective of maximising the lifetime return to the
organisation.
Management accountants are often involved in the preparation of detailed financial analysis for
life-cycle costing, including identifying opportunities to improve long-term performance.
• Determine the costs and benefits of a product or service using life-cycle costing.
At the end of this activity you will be able to compare two alternatives using life-cycle costing
and recommend which alternative an organisation should pursue.
Scenario
You are a management accountant working at Tech Centra, a manufacturer of computing
goods. You report to Nigel Hayek (CFO). The company is currently assessing two alternative
development options regarding their new Oval Plate tablet, and would like to make a decision
by the end of the month.
maaf12109_act_01

ACT
The following information is available on the two alternatives:
Oval Plate tablet alternatives
Alternative 1 Alternative 2 Notes
Launch date 01.01.20Y0 01.01.20Y0
Termination date 30.06.20Y1 30.06.20Y1
Sales units (year ending June 20Y0) 65,000 65,000
Sales units (year ending June 20Y1) 70,000 85,000
Retail price (excluding GST) $900 $900
Materials cost (per unit) $450 $425
Direct labour cost (per unit) $65 $60
Variable manufacturing overheads (per unit) $20 $15
Fixed manufacturing overheads (per month) $175,000 $150,000
Distribution costs (per unit) $25 $25
Other selling costs (per unit) $55 $55
Support costs (per month) $50,000 $35,000
Warranty claims 5.00% 3.50% Of sales $
R&D costs $20,000,000 $30,000,000 From 01.01.20X9

to 31.12.20X9
Tech Centra has a 30 June year end and uses full absorption costing. The company expects its
products to achieve a minimum gross margin of 40% and an average return on investment
(ROI) of 15% per annum for the life of its products.
Tech Centra has adopted a just-in-time inventory management system that results in no
inventory of finished goods being held at period end (i.e. all items produced are sold in the
month of production).
All warranty claims are expected in the year of sale.
Tasks
Nigel has asked you to complete the following tasks to enable a decision to be made about
which development option the company should pursue:
1. Prepare a financial analysis for each alternative.
2. Identify three (3) key pieces of information which are relevant to deciding which alternative
Tech Centra should select.
3. Identify two (2) additional factors that Tech Centra should consider in making its decision.
4. Recommend which alternative Tech Centra should select. Justify your selection.

ACT
Solution
1. A summary of the financial results for each alternative is contained in the table:
Alternative 1 Alternative 2
Gross margin ($’000) 46,125 57,300
Gross margin (%) 37.96 42.44
Net profit ($’000) 8,350 9,945
Net profit (%) 6.87 7.37
Life-time ROI (%) 41.75 33.15
2. Key information for selecting the preferred alternative would include:

• The total gross margin for Alternative 1 is 37.96%, and for Alternative 2 is 42.44%.
Tech Centra’s target gross margin on its products is 40%; therefore, Alternative 1 fails
the requirement while Alternative 2 meets it.
• Given that both alternatives run for 2.5 years (including the R&D phase), the target ROI
would be approximately 37.5% (15% × 2.5 years). The ROI on Alternative 1 is 41.75%
and on Alternative 2 is 33.15%. Therefore, Alternative 1 passes the requirement, while
Alternative 2 fails it.
• Alternative 1 achieves a net profit from sales of 6.87%, while Alternative 2 achieves 7.37%.
• Alternative 2 delivers a higher total net profit than Alternative 1; however most of this
extra profit is not derived until 20Y1.
3. Additional factors that should be taken into account in making a decision include:
• As Alternative 2 provides a higher quality product (resulting in less support and
warranty costs), how would this impact the perception of the brand, and therefore the
sale of other products?
• 56.7% of Alternative 2 sales are in 20Y1, versus 51.9% for Alternative 1. This suggests
a higher risk profile for Alternative 2, as more sales occur in a later period. It would
be worthwhile to understand the reasoning behind the difference in the unit
sales profile.
• Are there additional features in Alternative 2 that help reduce support and warranty
costs, and can they be leveraged into other products sold by Tech Centra for the
additional R&D costs?
• What level of fixed manufacturing overheads will be incurred regardless of this
decision, and therefore may be irrelevant to this decision?
4. Tech Centra should adopt Alternative 1, as it is lower risk and meets the ROI benchmark.

ACT
Task 1
Step 1 – Analyse background information
Review the background information and separate into the following categories:
• Fixed and variable costs.
• Revenue.
Determine which period each item of information is relevant to.
Step 2 – Perform calculations for each component

Based on the information in Step 1, calculate both the revenue and cost components for
each period.
Step 3 – Assemble information

Assemble the calculations from Step 2 and calculate gross margin, net profit and ROI.
Alternative 1
Base 30-Jun-X9 30-Jun-Y0 30-Jun-Y1 Total
Sales units 65,000 70,000 135,000
Sales price $900 $900
Total sales $58,500,000 $63,000,000 $121,500,000
COGS
Materials (per unit) $450 $29,250,000 $31,500,000 $60,750,000
Labour (per unit) $65 $4,225,000 $4,550,000 $8,775,000
Variable manufacturing $20 $1,300,000 $1,400,000 $2,700,000

overheads (per unit)
Fixed manufacturing $175,000 $1,050,000 $2,100,000 $3,150,000

overheads (per month)
Total COGS $35,825,000 $39,550,000 $75,375,000
Gross margin $22,675,000 $23,450,000 $46,125,000
Gross margin (%) 38.76% 37.22% 37.96%
Other costs
Distribution costs (per unit) $25 $1,625,000 $1,750,000 $3,375,000
Other selling costs (per unit) $55 $3,575,000 $3,850,000 $7,425,000
Support costs (per month) $50,000 $300,000 $600,000 $900,000
Warranty claims (% of sales) 5% $2,925,000 $3,150,000 $6,075,000
R&D costs $10,000,000 $10,000,000 $0 $20,000,000
Total other costs $10,000,000 $18,425,000 $9,350,000 $37,775,000
Net profit ($10,000,000) $4,250,000 $14,100,000 $8,350,000
Net profit (%) 7.26% 22.38% 6.87%
Lifetime ROI 41.75%

ACT
Alternative 2
Base 30-Jun-X9 30-Jun-Y0 30-Jun-Y1 Total
Sales units 65,000 85,000 150,000
Sales price $900 $900
Total sales $58,500,000 $76,500,000 $135,000,000
COGS
Materials (per unit) $425 $27,625,000 $36,125,000 $63,750,000
Labour (per unit) $60 $3,900,000 $5,100,000 $9,000,000
Variable manufacturing $15 $975,000 $1,275,000 $2,250,000

overheads (per unit)
Fixed manufacturing $150,000 $900,000 $1,800,000 $2,700,000

overheads (per month)
Total COGS $33,400,000 $44,300,000 $77,700,000
Gross margin $25,100,000 $32,200,000 $57,300,000
Gross margin (%) 42.91% 42.09% 42.44%
Other costs
Distribution costs (per unit) $25 $1,625,000 $2,125,000 $3,750,000
Other selling costs (per unit) $55 $3,575,000 $4,675,000 $8,250,000
Support costs (per month) $35,000 $210,000 $420,000 $630,000
Warranty claims (% of sales) 3.50% $2,047,500 $2,677,500 $4,725,000
R&D costs $15,000,000 $15,000,000 $0 $30,000,000
Total other costs $15,000,000 $22,457,500 $9,897,500 $47,355,000
Net profit ($15,000,000) $2,642,500 $22,302,500 $9,945,000
Net profit (%) 4.52% 29.15% 7.37%
Lifetime ROI 33.15%

ACT
Task 2
Step 1 – Identify Tech Centra performance benchmarks
Based on the background, the key performance benchmarks for Tech Centra are:
• Gross margin – 40%.
• ROI – 15% per annum.
Step 2 – Compare alternative financial performances

Based on the calculations in Task 1, benchmark the performances against each other and the
Tech Centra requirements.
Tech Centra Alternative 1 Alternative 2

requirements
Gross margin ($’000) 46,125 57,300
Gross margin (%) 40 37.96 42.44
Net profit ($’000) 8,350 9,945
Net profit (%) 6.87 7.37
Lifetime ROI (%) (15% × 2.5) = 37.5 41.75 33.15
Step 3 – Analyse the information

Analyse the information in Step 2. Key information for making a decision regarding the
preferred alternative would include:
• The total gross margin for Alternative 1 is 37.96%, and for Alternative 2 is 42.44%.
Tech Centra has a target gross margin on its products of 40%; therefore, Alternative 1 fails
the requirement, while Alternative 2 meets it.
• Given that both alternatives run for 2.5 years, the target ROI would be approximately 37.5%.
The ROI on Alternative 1 is 41.75% and on Alternative 2 is 33.15%. Therefore, Alternative 1
passes the requirement, while Alternative 2 fails it.
• Alternative 1 achieves a net profit from sales of 6.87%, while Alternative 2 achieves 7.37%.
• Alternative 2 delivers a higher total net profit than Alternative 1; however, most of this extra
profit is not derived until 20Y1.
Task 3
Step 1 – Analyse the background information
Review the background information and what is proposed in order to determine the qualitative
factors that would be important to Tech Centra in making this decision.
Step 2 – Document analysis

Additional factors that should be taken into account in making this decision include:
• As Alternative 2 provides a higher quality product (less support and warranty costs), how
would this impact the perception of the brand, and therefore the sale of other products?
• 56.7% of Alternative 2 sales are in 20Y1, versus 51.9% for Alternative 1. This suggests
a higher risk profile for Alternative 2, as more sales occur in a later period. It would
be worthwhile to understand the reasoning behind the differences in unit sales profiles.
• Are there additional features in Alternative 2 that help reduce support and warranty costs,
and can they be leveraged into other products sold by Tech Centra for the additional
R&D costs?
• What level of fixed manufacturing overheads will be incurred regardless of this decision,
and therefore may be irrelevant?

ACT
Task 4
Step 1 – Consider all available information
There is no correct answer to this question: the key is being able to justify the decision.
Based on the preceding analysis, the following would be appropriate:
Alternative 1 Alternative 2
Gross margin meets Tech Centra criteria 
ROI meets Tech Centra criteria 
Highest net profit to sales ratio 
Quality perception of brand 
Lower risk 
The final decision will be based on which criteria management see as most important. If Tech
Centra has reasonable cash reserves and a quality strategy, then Alternative 2 is more likely.
If cash is limited, then Alternative 1 is the more suitable option.

Based on the background information, Alternative 1 should be selected, as it meets one of Tech
Centra’s financial performance targets and is, prima facie, less risky.
An alternative answer would be to recommend Alternative 2. Justification for this alternative
would need to link to higher net profit ratio and quality perception of the brand.

ACT
Activity 9.2
Target cost for a special order
Introduction
Target costing is a tool for managing life-cycle costs through decisions taken during the
pre‑production phase of a product or service’s life, when opportunities for achieving substantial
cost savings over the life of the product are greatest.
Target costing can also be used to identify opportunities for reducing the cost of providing
existing goods and services to customers.
• Apply target costing.
At the end of this activity you will be able to review a cost structure and determine
opportunities to reduce costs in order to achieve required cost levels.
Scenario
You are the group management accountant at Accutime, where Graham Anderson, the chief
financial officer (CFO), has asked you to provide support to the sales and marketing department
regarding a recent opportunity.
Accutime’s newly released TCXOv5 has been a great success, and sales are up 15% on the
previous model, the TCXOv4.
Accutime has been approached by one of its customers, Special Orders, which does not
normally purchase items in the TCXO range. Special Orders has an order for a new toy that
requires a component similar to the TCXOv5. The toy is a one-off Christmas special, and
is therefore not expected to be made again.
Special Orders has said that for it to meet its customer price point, it would need to be able
to buy the TCXOv5 from Accutime at $0.50 each. Based on Special Orders’ contract, it needs
to purchase 120,000 units.
From a review that was undertaken by the finance department in March, you have been able
to extract the following information in relation to the TCXOv5 and TCXOv4.

ACT
March current year March last year
TCXOv5 TCXOv4
Per unit Total Per unit Total
Units sold 64,775 56,250
Sales $ $0.6500 $42,103.75 $0.6000 $33,750.00
COGS
Materials $0.2450 $15,869.88 $0.2200 $12,375.00
Direct labour $0.0875 $5,667.81 $0.0850 $4,781.25
Variable manufacturing overheads $0.0700 $4,534.25 $0.0650 $3,656.25
Variable maintenance overheads $0.0550 $3,562.63 $0.0500 $2,812.50
Total COGS $0.4575 $29,634.57 $0.4200 $23,625.00
Gross profit $0.1925 $12,469.18 $0.1800 $10,125.00
Gross profit margin (%) 29.62% 29.62% 30.00% 30.00%
Order processing $2,950.00 $2,812.50
Distribution costs $2,526.23 $2,025.00
Total other costs $5,476.23 $4,837.50
Net profit $6,992.95 $5,287.50
Net profit margin (%) 16.61% 15.67%
Orders processed 118 110
Average order size $356.81 $306.82
Distribution costs as a % of sales 6.00% 6.00%

Note: Accutime has target gross margins of 30% and net profit margins of 15% for all its products.
Tasks
1. Determine if Accutime should accept Special Orders’ order, based on the March analysis.
Assume that Accutime has sufficient excess capacity to produce the order.
2. Before accepting Special Orders’ order, identify two other non-financial issues that
Accutime should consider.

ACT
Solution
1. The order should be rejected, as the proposal from Special Orders does not meet either
of Accutime’s requirements. Gross margin is 8.5% against a target of 30%, and net profit
margin is 2.46% against a target of 15%.
2. Non-financial issues that Accutime should consider prior to accepting the order from
Special Orders include:
• The potential for further orders of other products from Special Orders.
• The realistic option that Special Orders has for sourcing an alternative item at a similar
price from a competitor.
• The availability of capacity within Accutime’s factory to be able to make the order.
• The potential impact on the market for TCXOv5 should an existing customer discover
the special pricing provided to Special Orders.
Task 1
Step 1 – Calculate gross and net profit margins
Based on the proposed pricing from Special Orders, and the March information for the
TCXOv5, calculate the gross profit and net profit for Special Orders.
Special Orders proposal
TCXOv5
Per unit Total
Units sold 120,000
Sales $ $0.5000 $60,000.00
COGS
Materials $0.2450 $29,400.00
Direct labour $0.0875 $10,500.00
Variable manufacturing overheads $0.0700 $8,400.00
Variable maintenance overheads $0.0550 $6,600.00
Total COGS $0.4575 $54,900.00
Gross profit $0.0425 $5,100.00
Gross profit margin (%) 8.50% 8.50%
Order processing $25.0000 $25.00
Distribution costs $3,600.00
Total other costs $3,625.00
Net profit $1,475.00
Net profit margin (%) 2.46%
Order processing cost is $2,950 ÷ 118 = $25
Distribution cost is 6% of sales value

ACT
Step 2 – Assess gross and net profit margins

Based on returns determined in Step 1, the order should be rejected, as the proposal from
Special Orders does not meet either of Accutime’s requirements.
Gross margin is 8.5% against a target of 30%, and net profit margin is 2.46% against a target
of 15%.
Task 2
Review the background to assess the non-financial issues that Accutime should consider prior
to accepting the order from Special Orders. These would include:
• The potential for further orders of other products from Special Orders.
• The realistic option that Special Orders has for sourcing an alternative item at similar
pricing from a competitor.
• The availability of capacity within Accutime’s factory to be able to make the order.
• The potential impact on the market for TCXOv5 should an existing customer discover the
special pricing provided to Special Orders.

ACT
Activity 9.3
Cost-volume-profit analysis
Introduction
Cost-volume-profit (CVP) analysis is used to determine the level of sales at which total
revenue and costs are equal, and above which profit is made. Management accountants are
often involved in the preparation and interpretation of CVP analysis. This activity links to
learning outcome:
• Prepare a CVP analysis.
At the end of this activity you will be able to prepare a CVP analysis.
Scenario
You work for the Australian Institute of Leadership (AIL), which will be running the upcoming
International Leadership Conference in Melbourne. You have compiled the following financial
information, which is based on previous experience of running this conference:
Cost of running the conference (see note 1) $450,000
Revenue per person attending conference $500
Marginal cost per attendee $60
Expected number of people attending 1,000

Note 1 : Excludes the marginal cost per attendee.
The following is an extract from a planning meeting for the above conference, attended by the
organising committee (assume that their names are A, B and C):
A: Why don’t we drop the international keynote speaker who has quoted $20,000 and
replace him with a local speaker who will charge $5,000? We will save $15,000 for half an
hour’s work.
C: The main reason why many people will be coming to the conference is to listen to the
current keynote speaker. Dropping the keynote speaker for a relatively unknown speaker is
highly risky.
B: Past experience shows that this event normally results in about 60 people signing up as new
member of AIL, meaning we earn extra annual member subscriptions of $300 from each
of them. We know that once a person has signed up as a member, 90% of them stay on for
life (the remaining 10% pay just for their first year’s subscription and then leave), and the
average member is with us for 30 years.
A: I have received an offer from the Australian Institute of Influencers (AII). They would like to
sponsor the conference and are prepared to pay $50,000 up front to be the sole sponsors.

ACT
B: How could you even consider using AII as sponsors? They will ‘steal’ some of the potential
new members, and the whole point of the conference is to promote our organisation, not
theirs.
C: I do accept that instead of us signing up 60 new members, with AII as the sole sponsor we
will probably sign up around 30, but you can’t just disregard an offer of $50,000 with no
related costs.
AIL’s cost of capital is 8%.
Tasks
1. Calculate the break-even number of delegates.
2. Provide advice regarding the issues below, take into account both financial and
non‑financial factors:
i. Determine whether the conference should go ahead (assume that the existing keynote
speaker is used). Note that present value tables are available in the CSG. Assume the
new membership subscriptions obtained from the conference occur in year 1 when
calculating the present value of the annuity payment (i.e. over a 30 year period).
ii. Consider whether the international keynote speaker should be replaced with a local
speaker.
iii. Consider whether the $50,000 from AII should be accepted in return for them being the
sole sponsors.

ACT
Solution
Task 1
Break-even number of people attending = fixed cost ÷ contribution per attendee
= $450,000 ÷ ($500 – $60)
= 1,023 people.
Task 2
(i)
If the break-even point of 1,023 delegates was compared to the expected number of 1,000
delegates, then from a short-term financial perspective, the conference should not go ahead.
However, the following two factors need to be taken into consideration:
Factor 1
Even if the conference is not profitable it could be regarded as an effective investment in
marketing, as the purpose of the conference is to promote AIL.
Factor 2
The present value of 60 new members should also be taken into consideration. This can be
calculated as follows:
= [60 members × 90% retention] × $300 per year × annuity factor (based on 8% and 30 years)
PLUS [60 members × 10% retained for just the first year] × $300
= 60 × 90% × $300 × 11.258 PLUS $1,800
= $184,180
If the present value of the new members’ subscriptions was taken into account, then the
contribution of the conference could be calculated as follows:
[Contribution from conference] + [PV of extra subscriptions] – [fixed cost]
= [($500 - $60) × 1,000] + [$184,180] – [$450,000]
= [$440,000] + [$184,180] – [$450,000]
= $174,180
(ii)
There is insufficient information to calculate whether the international speaker should be
replaced with a local one. It is clear that there will be a saving of $15,000; however, what is not
clear is what the reduction in the number of people attending the conference will be. Based on
C’s comment that “The main reason why many people will be coming to the conference is to listen to the
current keynote speaker. Dropping the keynote speaker for a relatively unknown speaker is highly risky,”
it would be suggested that the international speaker should be retained, as taking a high risk
decision to improve the profitability by $15,000 would not be advisable.
(iii)
If accepting AII’s sponsorship would result in the loss of 30 new members, then the sponsorship
offer should be rejected on both financial and non-financial grounds, as follows:
• The loss of 30 member would be half that calculated above for 60 members (i.e. half of
$184,180, which is $92,090). This can be compared to the $50,000 in sponsorship income.
• Accepting AII’s offer would go against AIL’s aim of running the conference to promote
itself.

ACT
Unit 10: Cost management II
Activity 10.1
Preparing a cost hierarchy
Introduction
As a management accountant you may be called on to evaluate the feasibility of implementing
an ABC system, and also to deliver it. The starting point of any ABC review is to consider the
activities undertaken by the business and then prepare a cost hierarchy classifying them.
A cost hierarchy is a stepped classification of costs, from those directly traceable to the final
product or service to those that have an indirect connection and need to be allocated. Under a
cost hierarchy there are four levels, beginning with those activity costs directly relating to the
output (the unit-level) through to organisational overheads (facility-sustaining costs).
• Apply activity-based costing (ABC) to provide information for decision-making
(activity‑based management (ABM)).
At the end of this activity you will be able to complete a cost hierarchy for a manufacturing
organisation.
Scenario
This activity is based on the Accutime Ltd (Accutime) case study.
You are a management accountant working for Accutime and you report to Graham Anderson,
the CFO.
Graham is thinking about implementing an ABC system for Accutime. To begin the pilot study,
he has asked you to prepare a cost hierarchy for Accutime’s manufacturing plant in Sydney.
maaf12110_act_01

ACT
Task
For this activity you are required to use the table provided and:
1. Categorise each activity cost according to the cost hierarchy.
2. Prepare a table presenting your analysis, including your rationale for the category assigned
to each activity.
Table of activities
Activity cost Cost hierarchy Rationale

level
Cost of setting up the cutting and lapping machines
Procurement costs relating to placing orders, and receiving and

paying for crystal blanks from Chinese suppliers
Occupancy costs of the Sydney premises, including head office and

plant space, building depreciation, and maintenance and insurance
Cost of etching quartz blanks in the machine room
Engineering costs associated with designing TCXOs
Indirect manufacturing labour costs supporting direct manufacturing

labour engaged in production of quartz blanks
Promotional costs associated with (trade) advertising TCXOs

ACT
Solution
The following table categorises each activity cost by cost hierarchy level for Accutime and
explains the rationale for the category assigned to each activity.
Table of activities
Activity costs Cost hierarchy level Rationale
Cost of setting up the cutting and lapping Batch-level Once set up, the machines will be used
machines to manufacture a number of units
Procurement costs relating to placing orders, Batch-level The orders will cover the manufacture
and receiving and paying for crystal blanks of a number of units
from Chinese suppliers
Occupancy costs of the Sydney premises, Facility-sustaining Space in which both corporate
including head office and plant space, building management and production takes
depreciation, and maintenance and insurance place
Cost of etching quartz blanks in the machine Unit-level Individual process for each unit
room
Engineering costs associated with designing Product-sustaining One time, upfront design costs for all
TCXOs subsequent production of those units
Indirect manufacturing labour costs Batch-level Indirect labour costs supporting

supporting direct manufacturing labour production
engaged in production of quartz blanks
Promotional costs associated with (trade) Product-sustaining Promotion of product to create

advertising TCXOs awareness in the market
Step 1 – Categorise each activity cost according to the cost hierarchy

The first step requires you to have a clear understanding of what a cost hierarchy is, and then
to categorise the activity costs for Accutime’s Sydney operation into the correct cost hierarchy
level.
The Accutime case study provides full details of the Sydney manufacturing plant, while the
CSG content provides a detailed explanation of the cost hierarchy levels.
You need to apply your knowledge of cost hierarchy levels from the CSG content to decide the
right cost hierarchy level for each Accutime activity.
Step 2 – Explain your rationale for the level assigned to each activity
You need to apply your knowledge of Accutime from the case study and your knowledge of
cost hierarchy levels from the CSG content to establish the rationale for each level allocated in
Step 1.
Step 3 – Prepare a table presenting your analysis

The third step is to complete the template provided to create a table presenting your analysis,
including your rationale for the classification selected.

ACT
Activity 10.2
Determining cost pools and cost drivers
Introduction
The process of ABC involves allocating costs incurred in making a product or providing a
service based on the actual costs incurred in producing it.
ABC involves allocating costs over two steps. The first allocation is to the activity being
undertaken; the second to the product or service being produced. Cost drivers are used in a
cascading process, driving resources through to activities – resource cost drivers drive resource
costs to activities; activity drivers then drive activity costs to outputs (products or services).
Determining cost pools and cost drivers is an initial and fundamental stage in performing an
ABC analysis.
• Apply activity-based costing (ABC) to provide information for decision-making
(activity‑based management (ABM)).
At the end of this activity you will be able to identify cost pools and cost drivers in a service
industry.
Scenario
Sunshu Limited (Sunshu) owns and operates several health resorts across Australasia. Sunshu’s
Dandenong resort service comprises accommodation, a restaurant, a gymnasium, tailored
fitness programs, a health-orientated educational program, and spa and holistic health facilities.
Each guest is accommodated in their own stand-alone cottage located within the five-hectare
property.
You are the management accountant at Sunshu and have been asked to identify the cost drivers
for the Dandenong property.

ACT
From the service brochure and cost analysis for the Dandenong resort you have the following
details of the package options and current costings.
Package options (all prices and inclusions are per person)
Package Period Single Double Inclusions

$ $
Weekend Friday lunch to Sunday brunch 1,375 1,100 Accommodation and all buffet-
style meals
Use of fitness facilities
Fitness assessment on arrival
Two spa treatments
Week Sunday lunch to Friday brunch 2,750 2,200 Accommodation and all buffet-
style meals
Use of fitness facilities
Fitness assessment on arrival
Fitness and educational program
Three spa treatments
Current costing
Area Fixed costs per month Variable costs

$ $
Accommodation (servicing rooms) 10,000 150 per room per day
Kitchen 10,000 65 per day per guest
Room service 5,000 10 per day per guest
Fitness centre 15,000 50 per assessment
Spa and health centre 25,000 75 per session
Reception (check in/out) 17,250 N/A
Human resources (back office) 50,000 N/A
Promotional costs 15,000 N/A
Marketing of packages 10,000 N/A
Cleaning of common areas 8,000 N/A
Gardening 5,000 N/A
Other 8,000 N/A

ACT
Task
For this activity you are required to use the table provided and:
Identify the activity cost driver for each cost pool.
Cost hierarchy level Activity cost pool Driver (cause)
Unit-level 1. Accommodation (servicing rooms) 1.
2. Fitness centre 2.
3. Room service 3.
4. Spa and health centre 4.
Batch-level 1. Reception (check in/out) 1.
2. Kitchen 2.
Product-sustaining 1. Promotional costs 1.
2. Marketing 2.
Facility-sustaining 1. Cleaning of common areas 1.
2. Human resources (back office) 2.
3. Gardening 3.

ACT
Solution
Following is a completed table categorising the activity cost pools for Sunshu’s Dandenong
resort by cost hierarchy level and providing the activity driver for each pool.
Cost hierarchy level Activity cost pool Driver (cause)
Unit-level 1. Accommodation (servicing rooms) 1. Occupied room

2. Fitness centre 2. Assessments/visits
3. Room service 3. Orders taken
4. Spa and health centre 4. Spa treatments
Batch-level 1. Reception (check in/out)* 1. Number of guests

2. Kitchen 2. Number of menu offerings (eg
breakfast offering/lunch offering/
dinner offering)
Product-sustaining 1. Promotional costs 1. Number of campaigns

2. Marketing 2. Number of packages offered
Facility-sustaining 1. Cleaning of common areas 1. Days open

2. Human resources (back office) 2. Staff employed
3. Gardening 3. Hectares of garden
* Based on packages offered and check in (Friday and Sunday) and check out (Sunday and Friday) times.
Step 1 – Identify the activity cost driver for each cost pool
Using the information provided to determine the activities in Step 1, apply the case study
information, your industry knowledge and general commonsense to determine a reasonable
cause (driver) for the activity.
Step 2 – Prepare a table to present your analysis

The second step is to complete the template provided, listing the activity cost drivers.

ACT
Activity 10.3
Improving cost competitiveness using ABC
Introduction
This is an integrated activity combining the topics of activity based-costing (ABC), strategy, and
target costing and pricing.
In this activity you will identify the strategy that a business is pursuing, and identify two
business threats. You will then use ABC to calculate the cost of a food product and explain
why changing from cost based to market based pricing will enable a business to remain price
competitive. Finally you will explain how costs can be reduced by eliminating non-value adding
activities in order to improve profitability.
• Outline generic strategies that organisations use (Unit 1).
• Apply models for determining an organisation’s pricing structure (Unit 8).
• Apply target costing (Unit 9).
• Apply activity-based costing (ABC) to provide information for decision-making (activity-
based management (ABM)) (Unit 10).
Scenario
MyPies is a privately owned gourmet pie business founded by Bryce Dunn 10 years ago. Bryce
is passionate about his business, having seen it grow from humble origins in his own kitchen.
MyPies now operates out of a production facility in South Melbourne. A significant milestone
for the business was the recent signing of an exclusive supply agreement with Counts. Counts is
a supermarket chain operating only in Melbourne. However, the trade-off is that MyPies cannot
sell its product through any other supermarkets.
MyPies is known for making premium pies. Only the finest cuts of carefully selected meats
are used. No artificial ingredients or preservatives are used. With this unrivalled attention to
quality, MyPies has won several prestigious awards, including at the annual Melbourne Pie
Awards. Bryce promotes the pies as ‘using only the best Australian ingredients’.
Marketing and advertising for the business has focused strongly on Bryce as the face of MyPies.
Bryce has become a minor celebrity in Melbourne, appearing on MasterChef Australia as a
judge, as well as radio breakfast shows and morning television shows showcasing simple,
quality and delicious meals prepared easily. Bryce is a regular contributor to many local
community and charity events around Melbourne. These activities have helped to build MyPies
as a distinctive and trusted brand. However, although his goals include expanding the business,
Bryce has no appetite to expand his business outside of the Melbourne area.
Recently, MyPies long-term steak supplier went into liquidation, and MyPies has had to source
a long-term replacement that meets its high standards.
Consumer demand for gourmet pies is growing as consumer tastes become more sophisticated.
Evolving consumer tastes have also resulted in a growing demand for more exotic pie flavours,
which new but lesser-known competitors are now beginning to produce.

ACT
MyPies is under price pressure from cheaper pies of comparable quality, and from Counts,
which regularly pushes for price reductions from suppliers to draw more customers into
its stores.
These price pressures and the emergence of cheaper ready-made meals is forcing Bryce to
consider his pricing. MyPies products have always been priced based on a standard percentage
mark-up on full cost. Although Bryce is mindful of these price pressures, he believes that the
quality of the product will support the price. He wants to look more closely at MyPies costs,
particularly for its most popular product – the steak and kidney pie.
MyPies currently produces and sells 41,400 steak and kidney pies annually. The pies are sold
in packs of four at $15.00 per pack (net of goods and services tax (GST)). Comparable gourmet
pies now being sold at Counts and elsewhere sell on average for $3.50 per pie (net of GST).
The following activity information relates to the business’s overhead costs (Table 1), and activity
information specific to the steak and kidney pie product (Table 2).
Table 1: Overhead cost information

Activity Description Total cost
($)
Waste disposal Disposal of substandard raw material and defective 10,000

finished pies following the completion of quality control
procedures
Quality control Testing and inspection of incoming produce and finished 7,200
pies
Handling Moving ingredients to and from storage, and between 20,100

the production and packaging steps
Processing Pooled costs of the mixing ingredients production steps 35,000
Table 2: Activity information

Activity driver Activity quantity for all Activity quantity for steak
products and kidney product
Inspections 360 200
Kilograms disposed 20,000 10,000
Batches 900 620
Kilograms processed 140,000 50,000
A further allocation of common costs are made to each product. For the tasks required below,
ignore the common costs allocation.
Tasks
1. Identify the strategy that Bryce is currently pursuing (based on Porter’s generic strategies).
Justify your response.
2. Identify and explain two (2) threats from a strengths, weakness, opportunities and threats
(SWOT) analysis relevant to MyPies current circumstances.
3. Use the ABC information from Table 1 and Table 2 to calculate the total overhead cost of
steak and kidney pies per pack.
4. Explain how changing from the current cost-plus pricing approach to target pricing/costing
would assist MyPies in dealing with the pressures it faces on its selling prices.

ACT
5. Calculate by how much MyPies would have to reduce its current cost of steak and kidney
pies to achieve a mark-up of 30% and remain price-competitive with other competitors’
pies also being sold through Counts. Assume the total cost of the steak and kidney pack is
currently $13.00.
6. Explain why waste-disposal is a non-value activity, and outline how the cost of this activity
could be reduced (without detriment to customers) in line with achieving the required cost
reduction calculated in task (5) above.
Ignore GST implications

ACT
Solution
Improving cost competitiveness using ABC
Task 1
Focus strategy – MyPies is operating only in Melbourne, and is deliberately only serving this
geographic region.
Differentiated – premium pies, winner of prestigious awards, using only the best Australian
ingredients.
Task 2
Threats Impact on pursuing strategy
(Focus Differentiation)
Changing Tastes May erode the value of MyPies point of differentiation. New
competitors have been quicker to react to this emerging market
shift than MyPies.
Cheaper Pies May erode the value of MyPies point of differentiation based
on high quality. Customers may be satisfied with slightly less
attention to quality, in order to pay less.
Price pressure from Counts supermarket Being locked into an exclusive supply agreement means Counts
have significant capacity to place pressure on MyPies, as is
currently being seen in relation to price. Cost reductions to satisfy
price reduction pressures may result in cutting corners on quality,
eroding a key point of differentiation for MyPies.
Exclusive supplier agreement with Counts If Counts drop MyPies as a supplier, MyPies would lose a
significant customer
Task 3
Quantity
Total of activity
activity driver used: Total Activity Steak &
driver steak & cost driver kidney cost
Activity volume kidney $ rate $
Waste disposal 20,000 10,000 10,000 $0.50 5,000
Quality control 360 200 7,200 $20.00 4,000
Handling 900 620 20,100 $22.33 13,847
Processing 140,000 50,000 35,000 $0.25 12,500
72,300
35,347 Total overhead costs
3.42 Overhead cost per pack

(4 pies to a pack)

ACT
Task 4
A target costing/ pricing approach would assist MyPies with the price pressures they are
facing by:
• making MyPies pricing approach more focused on price expectations of the market (which
in this case are applying downward pressure) rather than setting prices based on cost; and
• encouraging MyPies to search for cost reduction opportunities with the aim of reducing
costs incurred to be more in line with the price the market is willing to bear, and the mark-
up/margin the business wishes to achieve.
Task 5
Total cost per pack $13.00 – provided
Total cost per pie $3.25 – provided
Cost reduction required (per pie):
Target Cost = Target Price /(1+30%)
= $3.50/1.30
= $2.69
Cost Reduction = $3.25 – $2.69
= $0.56
Task 6
Non-Value Adding-
Activities
Waste Disposal Why: Product being wasted is an internal issue, this provides no benefit to
the customer.
Waste Disposal How the cost of these activities can be reduced.

Reducing substandard meat received from the supplier. Perhaps this will
be resolved by finding another long-term supplier, or requiring suppliers
to undertake quality checks before goods are dispatched. Alternatively
require suppliers to incur the inspection, handling and product cost of any
defective material.
Placing greater attention on improving the quality of the manufacturing
processes (to get things right the first time) so less substandard pies
are produced.

ACT
Activity 10.4
Apply both traditional and ABC approaches
to a manufacturing company and compare
results
Introduction
• Apply activity-based costing (ABC) to provide information for decision-making (activity-
based management (ABM)).
• Assess the advantages and disadvantages of traditional and activity-based costing
approaches and when each should be used.
Scenario
Sunshine Cereal Bars manufactures a range of cereal bars and has been trading for five years.
Having started off as a small family business, it has grown significantly – from the original
three varieties, the company now produces 30 different product lines, selling to supermarket
chains and a variety of other customer groups.
The growth that Sunshine Cereal Bars has experienced is reflected in the profitability it has
achieved over the last five years. As a result of the company’s success, the chief executive officer
(CEO), Mandy Choy, has recently employed you as a management accountant to ensure the
growth of the company is appropriately managed.
Your immediate concern is that Sunshine Cereal Bars does not know which of its products are
making a profit, and you suspect that some are unprofitable. It is clear from your observations
that the management team does not have a strong understanding of cost structures. One of your
first tasks is to implement a pilot activity-based costing (ABC) system – that is, trial an ABC
system on three different products.
The products to be trialled are:
• Product 1: Chocolate Coated Cereal Bar.
• Product 2: Apricot Cereal Bar.
• Product 3: Campers Delight Variety Bar.
The costing information you have established for the three (3) products is outlined below in
Table 1:
Table 1: Activities, drivers and costs for the three (3) products
Activities Driver Total cost ($)
Purchasing and material handling Orders 440,000
Production inspection Inspection hours 300,000
Common support costs N/A 340,000
Total manufacturing overhead costs 1,080,000

ACT
Activity driver analysis for the ABC system reveals the following activity usage, relevant to the
three products, outlined in Table 2:
Table 2: Activity driver analysis – usage by product

Activity Product 1 Product 2 Product 3 Total
Orders 180 220 400 800
Inspection hours 20 20 60 100
Current financial data reveals the following revenue and costs information for the three
products, outlined in Table 3:
Table 3: Revenue and direct costs

Product 1 ($) Product 2 ($) Product 3 ($) Total ($)
Revenue 3,200,000 2,200,000 600,000 6,000,000
Direct costs 1,920,000 1,540,000 480,000 3,940,000
The current costing system (traditional system) allocates all the manufacturing overhead costs
based on the proportion of direct costs per product.
Tasks
1. Calculate the product costs and product profitability for Product 1, Product 2 and Product 3,
individually and in total, based on ABC principles. Round your calculations to the nearest
whole numbers.
2. Explain how changing the way costs are reported for the three (3) products at Sunshine
Cereal Bars by implementing an ABC system may change decision-making for these three
(3) products.

ACT
Solution
Task 1 Product profitability using ABC

Product 1 ($) Product 2 ($) Product 3 ($) Total ($)
Revenue 3,200,000 2,200,000 600,000 6,000,000
Direct costs 1,920,000 1,540,000 480,000 3,940,000
Purchasing and material handling 99,000 121,000 220,000 440,000
Product inspection 60,000 60,000 180,000 300,000
Common support 340,000
Manufacturing overhead costs allocated 159,000 181,000 400,000
Product Profitability 1,121,000 479,000 (280,000)
Total Profitability 980,000
Note: Under ABC principles, where there is no relevant allocation basis for overhead costs (e.g.
common support costs), do not include these costs as part of the product costs.
Task 2
Product 1 – higher profitability under ABC
Lower portion of overheads allocated under ABC ($159,000 compared to $526,294 under
traditional method – lower activity usage for orders, for all products and less inspection time
compared to product 3, despite higher revenue and direct costs than both other products) may
encourage the company to sell/ promote/ produce more of Product 1 because it delivers a higher
profit under ABC.
Product 2 – higher profitability under ABC

Lower portion of overheads allocated under ABC ($181,000 compared to $422,132 under
traditional method – lower activity usage for orders and less inspection time compared to
product 3 despite higher revenue and direct costs than product 3) may encourage the company
to sell/ promote/ produce more of product 2 because it delivers a higher profit under ABC.
Product 3 – greater loss under ABC

Higher portion of overheads allocated under ABC ($400,000 compared to $131,574 under
traditional method – the highest activity usage for orders and highest inspection time of all
three products). These results may encourage the company to stop producing product 3.
The reporting of costs and profitability under ABC also make it more transparent as to the
drivers of the costs. Product 3 is identified as having the highest activities of orders and
inspection hours (and therefore the highest costs of these activities in the product profitability).
By making this transparent, further investigation can follow to understand the reasons for these
higher activity usage, and determine whether these activities can be reduced.
See below for workings of traditional method which allows the comparison to be made between
the different costing approaches.

ACT
Product Profitability under the traditional costing approach
Product 1 Product 2 Product 3 Total
Revenue 3,200,000 2,200,000 600,000 6,000,000
Direct costs 1,920,000 1,540,000 480,000 3,940,000
Total manufacturing overhead
Proportion on direct costs 48.73% 39.09% 12.18% 100%
Manufacturing overhead allocated 526,294 422,132 131,574 1,080,000
Profitability 753,706 237,868 (11,574) 980,000

ACT
Activity 10.5
Customer profitability analysis
Introduction
A customer profitability analysis provides an organisation with information regarding which
customers and customer groups are providing superior and inferior levels of profit to an
organisation, and aims to improve future performance levels.
Management accountants are often called on to undertake product and customer profitability
analyses, and to work with management to identify opportunities for future improvement.
• Prepare a customer profitability analysis.
At the end of this activity you will be able to undertake a customer profitability analysis for a
product-based organisation.
Scenario
MyCoal Limited (MC) is an Australian-owned, publicly listed coal miner, with its flagship
thermal coal mine, BeMine (BM), located in the Hunter Valley region of New South Wales.
The company aims to maximise shareholder value through efficient organic growth and
acquisitions, while maintaining the highest safety standards for all MC employees and
contractors. There is also a strategic focus on advanced coal mining technology and investing in
cleaner coal production techniques.
BM’s customers include one (1) local and two (2) overseas electricity generators, from Korea
and China.
The following financial and management accounting information is for the year ended
30 June 2020:
Year ended 30 June 2020 Local Korea China
Sales revenue (A$ million) 158 230 275
Cost of production (A$ million) (72) (110) (131)
Gross profit (A$ million) 86 120 144
Gross profit (%) 54.40 52.17 52.36
Tonnes sold 1,800,000 3,000,000 3,600,000
Overhead costs
Logistics
Road transport (A$/tonne) 10 20 20
Port costs (A$/tonne) N/A 10 N/A
(All shipping costs from port to
customer destination are the
responsibility of customer)

ACT
Year ended 30 June 2020 Local Korea China

Sales and marketing (A$) 300,000 400,000 200,000
Overhead costs (cont.)

Quality control checks (hours) 3,000 9,000 6,000
Cost pool for quality control (total for the three (3) customers): A$2,160,000
Ordering
Orders processed and contracts 25 3 2
reviewed (interactions per year)
Cost pool for ordering (total for the three (3) customers): A$600,000.
Administration – other (%) 20 30 50

Cost pool for administration – other (total for the three (3) customers): A$1,200,000
Additional processing
Depreciation (A$ p.a.) 200,000 – –
Labour (A$/tonne) 2 – –
The sales contract for the Chinese customer is up for renewal in late 2020. With continued
downward pressure on the market price of thermal coal due to oversupply, MC’s management
is uncertain about whether it can maintain the current pricing level to them.
The local customer obtains almost 100% of its coal input from MC; however, new government
legislation setting targets for clean energy production to be achieved within five (5) years means
that there may be pressure on current volumes in favour of renewable energy sources such as
solar and wind power.
The previous method of allocating overhead costs to customers allocated all costs (after
production costs) on a pro-rata basis by revenue.
For the purposes of this activity, ignore GST.
Tasks
1. Calculate the profitability of the three (3) customers to BM using the customer profitability
information.
2. Analyse these customer profitability calculations and discuss and explain the results.
3. Calculate the respective profitability to BM of the three (3) customers using the overhead
allocation method of allocating all overhead costs for the customers on the basis of revenue.
4. Analyse and explain the differences between the results calculated in 1 and 3 above.
5. Based on the information provided and your analysis in 1 and 2 above, identify and explain
two (2) key customer cost/profit issues requiring MC’s attention for 2020 and beyond.

ACT
Solution
Task 1
The table below summarises the profitability to BM of the three (3) customers:
Local Korea China Total
Sales revenue ($) 158,000,000 230,000,000 275,000,000 663,000,000
Gross profit($) 86,000,000 120,000,000 144,000,000 350,000,000
Overhead costs ($) 23,200,000 91,900,000 73,560,000 188,660,000
Net profit per customer ($) 62,800,000 28,100,000 70,440,000 161,340,000
Net profit margin (%) 39.7 12.2 25.6 24.3
The detailed workings for the above summary are as follows:
Customer profitability analysis (CPA)
Year ended 30 June 2020 Local Korea China Total
Sales revenue ($) 158,000,000 230,000,000 275,000,000 663,000,000
Cost of production ($) (72,000,000) (110,000,000) (131,000,000) (313,000,000)
Gross profit ($) 86,000,000 120,000,000 144,000,000 350,000,000
Tonnes sold 1,800,000 3,000,000 3,600,000 8,400,000
Gross profit (%) 54.4 52.2 52.4 52.8
Share of revenue (%) 23.8 34.7 41.5 100.0
Share of gross profit (%) 24.6 34.3 41.1 100.0
Overhead costs
Logistic costs – road ($) 18,000,000 60,000,000 72,000,000 150,000,000
Logistic costs – port ($) 30,000,000 30,000,000
Sales and marketing ($) 300,000 400,000 200,000 900,000
Quality control checks ($) 360,000 1,080,000 720,000 2,160,000
Ordering ($) 500,000 60,000 40,000 600,000
Administration – other ($) 240,000 360,000 600,000 1,200,000
Depreciation ($) 200,000 200,000
Labour ($) 3,600,000 3,600,000
Total overhead costs ($) 23,200,000 91,900,000 73,560,000 188,660,000

ACT
Customer profitability analysis (CPA)
Profit per customer ($) 62,800,000 28,100,000 70,440,000 161,340,000
Share of net profit (%) 38.9 17.4 43.7 100.0
Note: While the share of revenue and share of gross profit % are not specifically required, this does provide useful
analysis information.
Task 2
From the above analysis, you make a number of conclusions (below).
Of the three (3) customers the local customer delivers the most profit to BM, at a net profit
margin of 39.7%, despite generating the lowest revenue dollars. This customer contributes
23.8% of the total revenue from the three (3) customers, and 38.9% of the total profitability.
The main reason for this is that this customer generates by far the lowest customer-related costs,
including the lowest allocation of logistics costs, quality control checks and administration,
helping to ensure it provides BM with a strong profit margin return.
The customer from Korea provides to BM a profit margin of 12.2% – the lowest of the three (3)
customers. Revenue from this customer is 34.7% of the total revenue. The net profit to BM is the
lowest of the customers ($28.1 million). The low profit margin is due to higher customer related
costs including additional logistic costs, a higher sales and marketing spend, and significantly
higher costs of quality control checking (triple the time spent in relation to the local customer).
The customer from China provides BM a net profit of $70.4 million representing a profit margin
of 25.6%. China was allocated the largest share of administration overhead costs, but a lower
share of all other overhead costs than Korea, the other overseas customer. Of the total revenue
and net profit from the three (3) customers, China represents 41.5% and 43.7% respectively.
Task 3
The table below shows the net profit to BM by customer and the net profit margin by customer
for the year ended 30 June 2020. The table allocates overhead costs on the basis of revenue
source.
Sales revenue ($) 158,000,000 230,000,000 275,000,000 663,000,000
Gross profit ($) 86,000,000 120,000,000 144,000,000 350,000,000
Overhead costs ($) 44,959,698 65,447,662 78,252,640 188,660,000
Net profit per customer ($) 41,040,302 54,552,338 65,747,360 161,340,000

ACT
The detailed workings for the above summary are as follows:
Sales revenue ($) 158,000,000 230,000,000 275,000,000 663,000,000
Cost of production ($) (72,000,000) (110,000,000) (131,000,000) (313,000,000)
Gross profit 86,000,000 120,000,000 144,000,000 350,000,000
Tonnes sold ($) 1,800,000 3,000,000 3,600,000 8,400,000
Gross Profit (%) 54.4 52.2 52.4 52.8
Share of revenue (%) 23.8 34.7 41.5 100.0
Share of gross profit (%) 24.6 34.3 41.1 100.0
Overhead costs
Logistic costs – road ($) 35,746,606 52,036,199 62,217,195 150,000,000
Logistic costs – port ($) 7,149,321 10,407,240 12,443,439 30,000,000
Sales and marketing ($) 214,480 312,217 373,303 900,000
Quality control checks ($) 514,751 749,321 895,928 2,160,000
Ordering ($) 142,986 208,145 248,869 600,000
Administration – other ($) 285,973 416,290 497,738 1,200,000
Depreciation ($) 47,662 69,382 82,956 200,000
Labour ($) 857,919 1,248,869 1,493,213 3,600,000
Total overhead costs ($) 44,959,698 65,447,662 78,252,640 188,660,000
Profit per customer ($) 41,040,302 54,552,338 65,747,360 161,340,000
Share of net profit (%) 25.4 33.8 40.8 100.0

ACT
Task 4
The table below shows your conclusions from the calculations in tasks 1 and 3:

($’000) ($’000) ($’000) ($’000)
Profit per customer 62,800 28,100 70,440 161,340

(overheads traced to
customers)
Profit per customer 41,040 54,552 65,747 161,340

(overheads allocated on
revenue basis)
Difference 21,760 (26,452) 4,693 0
Applying ABC principles improves the accuracy with which cost structures can be analysed,
as well as the accuracy with which respective contribution to profitability can be attributed to
each customer. The customer profitability analysis (CPA) highlights a profitability contribution
from the Local customer of $62,800,000, while allocating overhead on a revenue basis generates
only $41,040,302. In contrast, the customer from Korea generates only $28,100,000 profit when
CPA is applied using ABC principles, but when overheads are allocated on a revenue basis this
increases to $54,552,338. Overall, however, there can be no difference as it is only the allocation
that changes: there is no overall cost addition or cost reduction.
Using the CPA, the overhead costs for each customer are different and need to be allocated
accordingly (a revenue-based overhead allocation does not help to clarify understanding of
profitability by customer). Korea has additional Port costs, the highest sales and marketing
costs, and the highest number of quality control checks.
The Local customer has the highest number of orders processed (25 transactions of the 30 in
total) and the additional depreciation and labour costs unique to this local customer. Overall,
the profit margin from the Local customer is the highest (39.7%).

($’000) ($’000) ($’000) ($’000)
CPA net profit margin (%) 39.7 12.2 25.6 24.3
Net profit margin 26.0 23.7 23.9 24.3

(allocation on revenue
basis)
Difference 13.7 (11.5) 1.7 0
Under CPA, BM earned on the Local customer a net profit margin of 39.7%, which is the
highest margin earned on any of the three (3) customers. When overhead costs are allocated on
a revenue basis, the margin on the Local customer declines to 26%, and the margin on Korea
increases to 23.7%. There is no significant change in relation to the customer from China.

ACT
Task 5
Issues requiring MC’s attention for 2020 and beyond.
Identify key issue Explanation
Local customer yields the highest net There is no opportunity to increase volumes and it is uncertain
profit margin as to whether future sales volume can be maintained at the same
level (due to factors such as government regulation of renewable
energy). The future profits from this customer may be vulnerable
to certain regulatory risks
The margin on the Korea customer is Opportunities to change the current logistic operations
eroded by large logistics costs, a greater arrangements with this customer could be explored to reduce
number of quality control checks, and costs, and review the quality control requirements
the highest costs in relation to sales and
marketing, and to administration – other
Korean customer yields the lowest overall Potential to explore available options to discontinue supplying
net profit margin coal to this customer and find a more profitable alternative
The ability to negotiate higher prices is The ability of the company to negotiate favourable pricing at
largely driven by market forces the next contract negotiation with the Chinese customer will
be crucial to maintaining current net profit margin from this
customer

ACT
Activity 10.6
Assessing customer profitability analysis
Introduction
• Prepare a customer profitability analysis
Scenario
Lily Lowe’s Lollipops (LLL) commenced business 10 years ago as a privately owned
confectionery manufacturing company. The company is still privately owned, and although it
grew significantly in the first five years of operation, it has delivered limited growth in the last
five years. The company sells 60 different products to specialist candy retailers and stores (non-
supermarkets) only. LLL has built up a good reputation for servicing its customers across its
client base in Australia and New Zealand.
The LLL manufacturing operation is located in South Melbourne and has an adjoining
warehouse. Additional warehouses, operated by third parties, are used in the major cities
to ensure that LLL’s clients’ needs are always met in a timely and efficient manner. The
manufacturing operation has been running at 96% capacity and there is no immediate
possibility of expanding the current operations in South Melbourne (even though there is
warehouse capacity which is being rented out).
The current costing system allocates all selling, general and administration (SG&A) costs on the
proportion of revenue.
The new chief executive officer (CEO) of LLL, Lydia Chan, has been appointed to deliver
growth for the company. Your role as the business analyst includes providing useful
information and advising the CEO on possible actions.
You have provided Lydia with the customer profitability information about one key customer
(Customer 1) in the table below. ‘Common costs’ include the remaining SG&A overheads that
currently have no activity applied to them. The information is based on the end of year forecast
of the actual results.

ACT
Customer profitability forecast information
Item Customer 1 All other Total Total

customers quantity
Revenue $1,640,000 $36,440,000 $38,080,000
Cost of goods sold $750,000 $16,050,000 $16,800,000
Gross profit $890,000 $20,390,000 $21,280,000
SG&A activities and costs
Number of regular customer orders 500 8,000 8,500
Regular customer order processing cost $442,000
Number of rush orders* 800 4,900 5,700
Rush orders processing cost $684,000
Common costs $19,223,000
Operating profit $931,000
*Rush orders are additional to customer orders.
Tasks
1. Calculate the customer profitability for Customer 1 using profitability forecast information.
2. Assess whether it would be beneficial for LLL to complete a customer profitability
analysis across all its clients.

ACT
Solutions
Task1
Calculation of customer profitability
Customer 1
Gross profit $890,000
Allocation of SG&A
Customer orders $26,000 ($442,000 ÷ 8,500) × 500 orders
Rush orders $96 ,000 ($684,000 ÷ 5,700) × 800 rush orders
Total SG&A $122,000
Customer profitability $768,000
Task 2
A range of acceptable answers would include the following:
• Activity costs only represent 5.5% (1,126,000/20,349,000) of total SG&A costs, which
suggests that there is a lot more work required to capture other costs. Cost benefit may not
be beneficial.
• On the other hand, the total SG&A costs represent 54.8% (20,349,000/37,149,000) of the
total costs. This suggests that there is a high percentage of costs that could potentially be
allocated on an ABC basis (for customer profitability analysis (CPA) purposes).
• The profit margin difference between the customers under a CPA/ABC allocation and the
current system is hard to judge because there is only 5.5% allocated under the new ABC
approach. The current costing approach shows Customer 1 with a profit margin of only 1%
($13,625 ÷ $1,640,000 – by allocating all overhead costs based on proportion of revenue i.e.
allocating 4.3% of Total SG&A to Customer 1). When compared to the customer profitability
under the ABC approach, Customer 1 has 46.8% profit margin (common costs are not
allocated, which causes a significant difference).
• There needs to be more comparisons made to other customers and their profit margins
between the two costing approaches before determining the value of any new costing
system.
• The data collected is for only one key customer, representing only 4.3% of total revenue.
This suggests that there will be limited benefit in completing CPA for the remaining
customers, and that there would need to be a lot of customer analysis completed to get a
reasonable portion of revenue and costs covered by the customers.
• The current system of allocating SG&A based on revenue is not a good allocation basis.
Therefore, this should be changed, irrespective of any change to customer profitability
analysis.
• It would not be beneficial developing CPA across the range of smaller customers because
the cost in collecting the data would provide limited benefit.

ACT
Unit 11: Working capital management
Activity 11.1
Managing accounts receivable
Introduction
In this activity you will assess how an organisation is performing in terms of managing its
working capital. You will achieve this by examining the accounts receivable function and
identifying how improvements can be made in credit control and collections processes.
The activity links to unit learning objective:
• Assess working capital components and apply appropriate working capital management
techniques within an organisation.
At the end of this activity you will be able to assess the performance of the accounts receivable
function, and identify improvements that can be made to the credit control and collections
processes.
Scenario
This activity is based on SDT Solutions (SDT).
You are a management accountant at SDT, reporting to Charlene O’Shay, the CFO.
SDT has recently tendered for a large software development contract (worth $250,000) with a
potential new customer. As part of its initial feedback, the new customer has indicated that the
successful supplier will need to provide 45-day credit terms.
SDT’s standard credit terms are 30 days. In recent months, SDT has had a number of similar
requests for extension of trading terms but has declined them. Given the current trading
conditions, however, Philip McCaw, the chief operating officer (COO), believes it is only a matter
of time before SDT begins to lose business due to its lack of flexibility regarding this issue.
Assume the cost of capital for SDT is 12.5%.
maaf12111_act_02

ACT
Tasks
You have been asked by Charlene to prepare a review of SDT’s credit and collections processes.
1. Assess the implications for SDT’s working capital and business operations of providing the
potential new customer with 45-day credit terms instead of SDT’s standard 30-day terms.
2. Discuss specific actions that management could take to improve SDT’s working capital
position through managing its debtors better.

ACT
Solution
1. The implications for SDT’s working capital and business operations of providing extended
credit terms to the potential new customer include:
• The additional working capital requirement and the funding cost attached to this (the
interest cost incurred). Based on a cost of capital of 12.5%, the cost of providing the
extended terms would be $1,284.25.
• The increased risk of non-payment as the period between the work being done and
payment being received is extended.
Note: By not offering these terms, SDT would not gain the job and therefore would lose the
profit attached to the software development contract.
2. Specific actions that management could take to improve SDT’s working capital through
managing its debtors better include:
• Establish standard collection procedures.
• Establish a dedicated collections function.
• Assign experienced staff for collection activities, and assign less experienced staff to
understudy these staff.
• Allocate appropriate staff to specific collections roles. Do not use business development
staff who are more likely to be concerned with making new sales and may avoid
upsetting customer relationships by making awkward collection calls.
• Renegotiate credit terms to obtain a greater proportion of the fees upfront from
customers. This provides funds for paying business expenses and reduces the risk
of loss through bad debts.
• Implement improved credit assessment of customers before providing services.
Where a customer is assessed as high risk, negotiate a higher level of upfront payment
and agree to more regular payment terms (e.g. fortnightly rather than monthly).
• Employ an external collections agency where necessary, particularly in New Zealand
where a local presence might improve collectability and be more cost-effective than
employing a staff member for this activity.
• Formalise debtor reporting and set targets for staff responsible for collections.

ACT
Task 1
Step 1 – Calculate the implications of extending credit terms for the potential
new customer
Providing the potential new customer with 45-day terms instead of the standard 30-day terms
would mean that SDT needs to invest working capital to fund the $250,000 for 15 days more
than normal credit terms. This carries with it an interest cost as well as an increased risk of
default by the customer.
The dollar impact is calculated by taking the $250,000 being funded by the short-term finance
rate for SDT.
Since the cost of capital is 12.5%, the calculation would be:
(($250,000 × 12.5%) ÷ 365) × 15 = $1,284.25
Step 2 – Examine the implications of changing the policy for the broader
business operations
If SDT extends credit terms to this customer, a precedent could be set for other new customers.
Further, a precedent could also be set for existing customers to renegotiate their credit terms,
which would be less favourable for SDT.
The implications for SDT’s business operations of extending credit terms by 15 days include:
• Additional working capital requirement.
• Additional interest cost incurred on the increased working capital.
• Increased risk of non-payment as the period between the work being done and payment
being received is extended.
Note: By not offering extended terms SDT risks losing profitable business, whereas by offering
extended terms it potentially gains new profitable business.
Task 2
Step 1 – Review the CSG content and consider how management of debtors can
be improved
Techniques to improve management of debtors that may be considered for SDT include:
1. Establish a credit policy.
2. Make invoicing clear to facilitate payment.
3. Invoice as early as possible.
4. Reduce time to receive payment through offering easy options such as direct transfer
and BPAY.
5. Offer early settlement discounts.
6. Structured follow-up for overdue accounts.
7. Know the customers and establish relationships that make follow-up easy.
8. Monitor and report on the progress of debt collection.

ACT
Step 2 – Prepare a summary of specific actions that SDT management could take
to improve management of debtors and thereby SDT’s working capital position
It appears that SDT already employs strong controls over receivables. One of the items on the
agenda of the bi-monthly finance committee meeting is consideration of all current jobs with
a value of more than $100,000 to assess whether there are any issues that may result in the
job being delivered late or not to the required quality standard. The committee specifically
discusses any job with an estimated value of greater than $25,000 that has commenced since
the last meeting in order to determine key risks and issues.
Additionally, the quarterly reporting to the SDT board of advice includes client and job
risk assessment (where clients and/or jobs exceed $100,000). Again, this is illustrative of
an organisation that closely manages revenues and receivables.
Practical steps that SDT could take to improve its debtors management (and hence its working
capital position) include:
• Document standard collection procedures and ensure all staff are aware of these
procedures. Senior management support is essential for these to be effective.
• Employ staff experienced in collections for debt follow-up rather than using business
development staff for debt recovery. Using business development staff potentially adds
days to the collection cycle as they are more likely to be concerned with not upsetting
customers and may delay making collection calls. By separating these responsibilities, the
staff responsible for debt collections are able to form their own relationships and thereby
be in a position to identify potential issues with customers. While business development
staff should focus on sales, they still have a role to play in helping with collections.
• Obtain a greater proportion of the fees upfront for work undertaken. Given the nature of
a consulting business, SDT incurs most of its costs upfront (primarily staff time) and would
be unable to recover these should a customer not pay (unlike in a business where a tangible
product is sold and it may be possible to regain possession following non‑payment by
a customer).
• Ensure that all customers are properly credit assessed before providing credit rather than
providing credit to customers automatically. Where a customer is assessed as being higher
risk, ensure that appropriate mitigation is in place, such as upfront payment or terms
requiring more regular payment of accounts. SDT appears to have a strict review process
and monitors all jobs over $25,000 and all clients with cumulative jobs exceeding $100,000,
which will assist in credit management.
• Consider using a collections agency, particularly in New Zealand where a local presence
might improve collectability. Using a collection agency may be more cost-effective than
employing a staff member in New Zealand for debt collection.
• Formalise debtor reporting and set targets for staff responsible for debt collections.
• Ensure that there is appropriate authorisation of all bad debt write-offs and carefully
monitor debt write-off levels. Through appropriate management, it would appear that SDT
has experienced a low level of bad debts. In addition, the profile of customers being serviced
appears to be of a high quality; in particular, government clients are highly unlikely to
default on payment.

ACT
Activity 11.2
Managing inventory
Introduction
Understanding the importance of inventory management and assisting in the management of
an organisation’s investment in inventory as part of its working capital are important skills of a
management accountant.
At the end of this activity you will be able to apply inventory control models to an
organisation’s working capital.
Scenario
Supreme Coffee Shop (Supreme) is a privately-owned and run coffee shop located in a busy
shopping centre in the centre of Newcastle which is on the east coast of Australia. Supreme has
built its reputation by providing a wide range of imported coffee blends from which customers
can select when choosing any espresso-based coffee. Supreme has been in negotiations with one
of its overseas suppliers for a unique Brazilian coffee (Favela). This coffee will be supplied in
200 kilogram bags, and air freighted from Rio de Janeiro to Newcastle. It is expected that this
coffee will only be available for purchase from the supplier six (6) months of the year. It will
have a lead time of four (4) weeks.
Supreme purchases the raw beans which it then roasts and grinds to its requirements.
The process of roasting and grinding the beans results in a 5% wastage factor. The process can
be illustrated as follows:
Brazilian supplier Supreme
Coffee airfreighted
Roast Grind Brew Consumer
beans
coffee
4 weeks 5% wastage
You have been supplied with the following information in relation to Favela coffee:
Expected weekly demand for Favela coffee grinds

25% probability 75 kilograms
Average cost per 200kg bag $2,000
Order process cost $150
Other carrying costs per 200kg bag $100
Process wastage factor 5%

ACT
Supreme’s coffees are normally sold at a mark-up of 100% on the purchase price. However,
due to the unique taste of Favela coffee, Supreme sells it at a 10% additional mark-up to what it
makes on other coffees.
Supreme has an expected return of 20%.
Tasks
1. Calculate the economic order quantity (EOQ) of Favela coffee beans for Supreme.
2. Calculate the reorder point of Favela coffee beans, assuming that Supreme wants to ensure
it does not run out of stock.
3. State whether Supreme should adopt EOQ in relation to Favela coffee. Justify your answer.
4. Calculate the stock-out cost per kilogram of Favela coffee grinds.

ACT
Solution
Demand
Average weekly usage (grinds) = (25% × 75) + (50% × 100) + (25% × 125) 100kg
Annual usage (grinds) = (100 × 52) 5,200kg
Add processing (grinding) loss 5%
Kilograms of grinds required = (5,200 × (1 + 5%)) 5,460kg
Bags required = (5,460 ÷ 200) 27.30
From background
Average cost per 200kg bag $2,000
Order process cost $150
Other carrying costs per 200kg bag $100
Expected Return = (20% × $2,000) $400
1 EOQ
_____________
√
2 × 27.30 × $150
____________

   
      
$400 + $100
= 4.05 bags
= 5 bags (rounded up)
2. Reorder point
Lead time 4 weeks
Bean usage per week = 125* × (1 + 5%) 131.25
Lead time bean usage = (131.25 × 4) 525.00kg
*As Supreme does not wish to have any stock-outs, the maximum level of possible demand should
be used (125kg demand).
3. Supreme should not adopt the EOQ given that Favela coffee is only available from the
supplier six months of the year. Instead, it should purchase sufficient stock to cover the
six months.
4. Stock-out cost per kilogram
Cost per kilo grinds = ($2,000 ÷ 200) (1 + 5%) $10.50
Mark-up @ 110% = (110% × $10.50) $11.55
Selling price of Favela = ($10.50 + $11.55) $22.05
Margin = ($22.05 – $10.50) ÷ $22.05 52.38%
Stock-out cost = Loss profit on sales $11.55

ACT
Activity 11.3
Managing working capital
Introduction
In this activity you will assess how an organisation is performing in terms of managing its
overall working capital position. You will also identify and evaluate techniques to manage
specific areas of working capital that will be impacted by future expansion opportunities for
the business.
The activity links to the following unit learning objective:
At the end of this activity you will be able to evaluate the management of working capital.
Scenario
You are the new management accountant at a small sugar confectionery retail company,
Sweets 4 All. The company is family owned; however, the family aims to substantially grow the
business over the next two years in order to generate interest from other sugar confectionery
companies to acquire the business. The company currently operates three stores in one major
city.
You have been given the following information:
Selected financial accounts Actual year end 30 June 20X0 Forecast year end 30 June 20X1
$’000 $’000
Cost of goods sold (COGS) 1,240 1,800
Bank overdraft (181) (690)
Creditors (212) (102)
Debtors 7 9
Inventory 95 448
You have learned the following additional information:

• The demand for confectionery products is very seasonal, peaking during summer
(November–February) and specific calendar events.
• The forecast includes the opening of one new store.
• A major supplier offered a 1% discount for payments within 14 days of invoice. Sweets 4
All is planning to take this offer. Previous terms with this supplier called for payment at the
end of the month following delivery.
• The company imports 70% of the products from overseas.
• There are no price increases included in the sales or COGS forecasts.

ACT
• A major marketing campaign is planned for November 20X0, and for the new store opening
in February 20X1.
• The bank has been carefully monitoring the company’s liquidity and cash flow position
over the past two years, with further tightening of bank covenants likely in the future.
Tasks
1. Calculate the additional working capital required for the forecast year end 30 June 20X1.
2. Evaluate the key working capital components of the forecast for the year end 30 June 20X1
and discuss any cash flow concerns.
3. Identify and discuss two techniques that would support maintaining good control over
inventory in the planned new store.

ACT
Solution
1. Additional working capital requirements
Working capital items 30 June 20X0 30 June 20X1 Increase in working capital
$’000 $’000 (decrease)
Debtors 7 9 2
Inventory 95 448 353
Creditors (212) (102) 110
Total (110) 355 465
Note that the MAAF module focuses on debtors (receivables), inventory and creditors
(payables) as the main components of working capital.
2. Evaluation points to note:
• The forecast of a bank overdraft increasing from $181,000 to $690,000 may be
problematic given the close monitoring from the bank and an expectation of tighter
bank covenants.
• The overall increase required in working capital of $465,000 has arisen due to the
increase in inventory ($353,000) and creditors reduction ($110,000).
• The addition of a new store and the planned move to pay a major creditor earlier are
the two main contributing factors to the forecast increase in working capital.
• The new store necessitates an increase in inventory. However, the increase of $353,000
is high given the 30 June 20X0 year-end position of $95,000 for the existing three stores.
See inventory day’s calculations below showing the increase from 28 inventory days
to 91 inventory days.
• COGS are planned to increase 45% (based on volume increases) and inventory is
increasing 371%. The inventory number for 30 June 20X1 appears too high – even
allowing for the increase of an additional store.
• The bank overdraft facility will be further under pressure during the periods of the
marketing campaigns.
• Further consideration should be given to the decision about taking the discount
offered by creditors and paying early. This is placing further pressure on the bank
overdraft facility.
3. Techniques to utilise in order to manage inventory at the new store

• Benchmark to the existing three stores for the overall level of inventory. This can be
adjusted for the forecast size and level of revenue for the new store.
• Establish a target of inventory days by product category for the new store, based on best
practice of existing stores and relevant industry averages. This will ensure that attention
is placed on moving old inventory.
Inventory days calculation (n.b. based on the year end position rather than the average
of two periods)
To 30.6.20X0 Actual = $95,000 × 365 ÷ 1,240,000
= 28 days
To 30.6.20X1 Forecast = $448,000 × 365 ÷ 1,800,000
= 91 days

ACT
Activity 11.4
Analyse and evaluate working capital
performance, identify strategy and assess
activity-based costing information
Introduction
This is an integrated activity that combines the topics of working capital management, strategy
and activity-based costing.
For this activity, you are required to analyse and evaluate working capital, identify and justify
the strategy being undertaken, and assess additional information on overheads in an activity-
based costing context.
Unit 1
Unit 10
• Apply activity-based costing to provide information for decision-making (activity-
based management).
Unit 11
• Evaluate the management of working capital.
Scenario
Billy’s Bikes Shop Sydney (BBSS) is a privately owned bicycle store specialising in downhill
and freeride bikes. Billy has owned and run the business for five years, combining his technical
expertise in bicycles with his general business ‘savvy’ skills. Billy imports 90% of the bicycle
components from Europe (paying for them in euros) and assembles the downhill and freeride
bikes in the workshop attached to his store.
One of Billy’s success factors has been his reputation as a previous competitor in the Tour
de France bicycle race. Billy received a lot of media coverage during the five-year period of his
participation in the race, where he made the headlines for winning three of the mountain climb
stages. His client base has grown with many new clients keen to get their bicycles serviced by
Billy. His bicycle servicing segment is offered across all types of bikes.
Although Billy’s business has been very successful over the last five years, he has no intention
of growing it beyond the one store or employing other staff (he does employ a part-timer for
administration work). He has built a good reputation among the specialist biking fraternity
in Sydney, something that can be easily eroded if the wrong people interact with them. Billy’s
slogan on the counter of the shop outlines his message to his customers: ‘My aim is to provide
a superior, customer service-oriented bicycle store experience by a friendly, professional expert’.

ACT
Billy sponsors two bike ride events per year. In 20X8, these events cost $18,000, and this
increased to $20,000 in 20X9. The events have a large appeal to those in the 20–30-year-old
age bracket.
The business is affected strongly by seasonality. Seventy per cent of bike sales are made during
September to December, reflecting the spring to summer and Christmas periods. Throughout
20X9, the Australian dollar has appreciated against the euro.
Despite business being good, Billy seeks advice from you, a recently graduated Chartered
Accountant. Specifically, he is concerned because the business’s cash is declining and yet its
profit is increasing.
The following is a summary of the business’s financial performance and balance sheet data
as at 30 June 20X9, including all working capital items:
BBSS financial performance summary 20X7–X9
Percentage Percentage Actual Percentage Percentage Actual Actual

change of sales 30.6.X9 change of sales 30.6.X8 30.6.X7
20X8–X9 actual 20X7–X8 actual
20X9 20X8
$’000 $’000 $’000
Cash sales 156,000 189,000 198,000
Credit sales 1,096,000 922,000 869,000
Total sales 13% 100% 1,252,000 4% 100% 1,111,000 1,067,000
Cost of 10% 70% 882,000 1% 72% 801,000 791,000

goods sold
Gross 19% 30% 370,000 12% 28% 310,000 276,000

margin
Overhead 4% 17% 212,000 3% 18% 203,000 198,000

expenses
Net profit 48% 13% 158,000 37% 10% 107,000 78,000

before tax
Selected balance sheet data and related working capital days
Actual 20X9 Actual 20X8 Actual 20X7
Debtors balance $162,000 $92,000 $90,000
Debtor days To be calculated 36.02
Creditors balance $198,000 $224,000 $260,000
Creditors days 83.08 106.68
Inventory balance $214,000 $169,000 $142,000
Inventory days 79.25 70.86
Cash balance ($37,000) ($9,000) ($1,000)
Note: The business has a bank overdraft limit of $45,000.

ACT
Tasks
1. Analyse and evaluate the overall working capital management of BBSS over the
20X7–X9 period.
2. Identify and justify the strategy direction from Billy over the 20X7–X9 period (from Porter’s
generic strategies).
3. You have investigated further the gross margin and overhead expenses of BBSS for 20X9,
and have identified the following additional information:
Downhill bikes Freeride bikes Servicing Total

$
Gross margin 45% of the total 40% of the total 15% of the total 370,000
Gross margin Gross margin Gross margin
Overheads:
Sponsorship events 60% of total 40% of total N/A 20,000

sponsorship sponsorship
Number of Purchase 75 25 N/A 30,000

orders
Workshop assembly 50% 30% 20% 60,000

area
Assess whether this additional information on the overheads of BBSS provides support for
decision-making about the business.

ACT
Solution
1. The calculation for debtor days is:
($162,000 + $92,000) ÷ 2 × 365 ÷ $1,096,000
= 42.29 days
Billy is correct in being concerned about the business’s declining cash position, despite the
increase in demand for its products and services and the increase in profit. The points discussed
below highlight this issue.
Over the 20X8–X9 period, credit sales have increased by 19% and debtors have increased by
76%. The actual debtors collection period has increased by six days (42 – 36). As cash sales are
declining and credit sales are increasing as a portion of total sales, credit sales collections need
close monitoring. The growing importance of this area is highlighted by the general increase
in sales – however, the controls over debtor days collections are not occurring and the days
collections have been deteriorating.
The net working capital days increase is 38.26 days (in 20X9, 38.46 days (42.29 + 79.25 – 83.08);
in 20X8, 0.2 days (36.02 +70.86 – 106.68)). The net working capital dollar increase is $141,000
(in 20X9, $178,000 (162,000 + 214,000 – 198,000); in 20X8, $37,000 (92,000 + 169,000 – 224,000)).
BBSS has more debtors, is taking longer to collect payments from debtors, is paying creditors
earlier, and is holding inventory for longer periods. In 20X7, the net working capital was
($28,000). The trend of increasing sales since 20X7 is placing increasing pressure on the
company’s working capital. It appears that controls over working capital management are
not occurring.
Billy’s good reputation and networking with specialist biking fraternity contacts may be having
a negative impact on his working capital management – he is allowing his debtors to have
longer to pay, and paying his creditors earlier.
Overall, this presents a deteriorating position of working capital. The business’s cash position
has declined to the extent that the bank overdraft is nearly at the limit. If the current trend
continues, then the bank overdraft limit will be reached in the next financial year, and BBSS
will not be able to fund further increases in working capital (under existing arrangements).
The position of BBSS is likely to get worse in the short term. These calculations present the
position as at 30 June. With the seasonality of demand, inventory is likely to be higher from
late August through to late spring. This could be a significant issue for BBSS in surviving a
cash crisis.
Comparisons to industry averages will support targets for BBSS to achieve in its working capital
components. The debtors and creditors standard terms that Billy has established also need to be
clarified. However, in the short term the working capital issues need to be addressed.
Also note that the appreciating Australian dollar has supported the significant increase in gross
margin that has been achieved in 20X9. A change in direction of the currency movement could
have a significant impact on the profitability of the business. This would mean that profitability
and cash would be an issue.
2. Billy’s strategy direction over the 20X7–X9 period is a combination of Porter’s focused and
differentiated strategies, as follows:
• Differentiated
– specialised products of downhill and freeride bikes
– expertise from a professional biker, building on a good reputation
– friendly and customer service-oriented
• Focus
– Sydney only, no interest in expanding
– Targeting those in the 20–30-year-old age bracket.

ACT
3. The following calculations based on the activity-based costing data show specific product
profitability for BBSS in 2019:
Downhill Freeride Servicing Total

$ $ $ $
Gross margin 166,500 148,000 55,500 370,000
Overheads:
Sponsorship 12,000 8,000 20,000

events
Purchase orders 22,500 7,500 30,000
Workshop 30,000 18,000 12,000 60,000

assembly area
Common costs (not 102,000

allocated)
Total overheads 64,500 33,500 12,000 212,000
Product 102,000 114,500 43,500

profitability
Total profit 158,000
How this information supports decision-making about the business:

• 52% of the total overheads have been identified as cost pools that can be attributed
to the cost object (products). This leaves $102,000 remaining as unallocated
(common costs).
• All three products are shown as delivering a profit, so it does not appear that any
product is problematic or being subsidised by the other products.
• The product profitability information may support pricing decisions, although there
is no information on existing prices or a breakdown of sales according to products.
• The additional cost to provide the data for activity-based costing may not provide
enough benefit to a small business such as BBSS, which only has three distinct products.

ACT
Unit 12: Investment decisions
Activity 12.1
Cost of equity and WACC for a new
investment
Introduction
An organisation’s capital structure refers to the mix of long-term sources of funds employed.
The fixed costs of debt and preference share finance increase earnings per share and also
increase the variability (risk) of those earnings. It is important to understand whether a
company can affect its overall cost of capital (either favourably or unfavourably) by varying the
mix of long-term financing sources it uses.
• Calculate and apply weighted average cost of capital.
At the end of this activity you will be able to use the beta de-gearing and re-gearing formulas to
calculate the cost of equity and WACC for a new investment.
Scenario
You are the management accountant for Weldup Limited (Weldup), an Australian company
manufacturing parts for electric arc welding equipment. Weldup’s debt–equity ratio (in market
value terms) is 0.60, and the current cost of its debt finance is 13.75%. Weldup is currently
looking to diversify its business operations. Opportunities exist for expansion into weld-testing
technology, but Weldup has little idea of what return it should expect from this investment.
Weldup’s priority is to determine the weighted average cost of capital (WACC) for a typical
business in the weld-testing sector.
Weldup has identified Specific Australia Limited (SAL) as a company in the business of weld-
testing technology. SAL has a debt–equity ratio (in market value terms) of 0.25, and a beta of
1.21. Its shares are regularly traded on the Australian Securities Exchange (ASX). Weldup also
estimates the risk-free rate at 7%, and a market risk premium of 8%. The corporate tax rate is
expected to remain at 30%.
maaf12112_act_01

ACT
Tasks
For this activity you are required to assist in analysing the return required from the potential
move into weld-testing technology.
Complete the following tasks:
1. Calculate Weldup’s required rate of return (i.e. WACC) on this investment, using the capital
asset pricing model (CAPM) to calculate the cost of equity. Assume Weldup intends to
employ the same amount of leverage in the new venture as it presently employs.
2. Outline whether the figures calculated are likely to be realistic estimates of the required rate
of return on the investment. Identify any other actions you might take in order to improve
the analysis.

ACT
Solution
Task 1
The required rate of return for the project is 15.3%. This was calculated using a beta of 1.46 as
it intends to employ the same amount of leverage in the new venture as it currently employs.
Task 2
The figures calculated are unlikely to be realistic estimates of the required rate of return on the
investment because:
• The analysis assumes that the beta for SAL is a good surrogate for systematic risk in the
weld-testing sector.
The accuracy of the estimate for systematic risk in the weld-testing sector might be
improved by obtaining data on other organisations in this industry. This would provide
greater confidence in the reliability of the estimates calculated.
• The figures used for the risk-free rate and the market risk premium are estimates only.
If these estimates are reasonable, the calculation should be a realistic estimate of the
project’s required rate of return. However, given that they are estimates, it would be worth
using sensitivity analysis to understand the impact of any variations in the estimates.
• Weldup’s existing cost of debt has been used in the calculations. This implicitly assumes
that the proposed investment does not change the level of risk faced by lenders. This is
inconsistent with the calculation of the cost of equity where the impact of gearing on the
return required by investors is reflected.
As with the figures used for the risk free rate and the market risk premium, a sensitivity
analysis should be used to understand the impact of any variations in the level of risk faced
by lenders.

ACT
The steps outline the recommended approach for successfully completing each task.
Task 1
Step 1 – Identify the information need to calculate WACC
The WACC for the investment can be calculated as:
WACC kd ^1 t c h` j ke ` j
D E
V V
In order to calculate WACC you need the cost of equity. This will require Weldup’s equity beta
to be calculated. The cost of debt has been provided in the scenario, as has the financing mix.
Step 2 – Calculate asset or ungeared beta for the weld-testing sector

SAL’s equity beta cannot be used to calculate the cost of equity for Weldup as this reflects not
only the business risk in the weld-testing sector but the financial risk associated with SAL’s
level of gearing. Therefore, the asset or unlevered beta for SAL, the proxy company, must be
calculated first.
The asset or ungeared beta of SAL can be calculated as:
G
U
1 ^1 t c ha E k
D
1.21
61 ^0.70h^0.25h@
1.21
1.175
1.03
Step 3 – Calculate the equity or geared beta for Weldup

The equity beta of Weldup under its existing capital structure is calculated as:
G U :1 ^1 t c ha E kD
D
1.03 61 ^0.70h^0.60h@
1.46
The beta of 1.46 for Weldup is higher than that of SAL as Weldup has a higher level of gearing,
and hence financial risk, than SAL.
Step 4 – Calculate the cost of equity for Weldup’s investment

The next step is to calculate the equity beta of Weldup based on SAL’s asset beta and the
gearing of Weldup.
The cost of equity for the investment can be calculated using the CAPM as:
ke = rf + βG ^rm − rf h
= 0.07 + 1.46 ^0.08h
= 0.1868 or 18.68%

ACT
Step 5 – Calculate the WACC for Weldup’s investment

The WACC for the investment can be calculated as:
WACC kd ^1 tc h` j ke ` j
D E
V V
where: kd = 13.75%
tc = 30%
ke = 18.68%
V = D+E
D
Since E = 0.6, then D represents six parts of total financing and E represents 10 parts. Total
D 6
financing (D + E) therefore comprises 16 parts (being V). Therefore V = 16 ÷ 16 or 0.375 and
E 10
V = 16 or 0.625.
WACC 13.75% ^1 0.30h^0.375h 18.68% ^0.625h

3.61% 11.68%
15.29%
Task 2
Step 1 – Understand the assumptions underlying the calculations
Review the CSG content from the unit on investment decisions to understand the assumptions
underlying the CAPM model.
Also review the CSG content from this unit to understand how equity beta is adjusted for
different levels of gearing.
Step 2 – Consider the impact of variations in those assumptions

• Consider how any variations in the assumptions could be minimised.
• Consider the impact of changes in the assumptions on the final calculation of WACC.

ACT
Activity 12.2
Applying weighted average cost of capital
(WACC)
Introduction
This activity requires you to analyse the weighted average cost of capital (WACC) for Accutime
Limited (Accutime). You will also contrast Accutime’s WACC with the minimum return
demanded by the board of directors and outline possible implications.
• Calculate and apply weighted average cost of capital (WACC).
At the end of this activity you will be able to calculate and apply the WACC in relation
to investment decisions.
Scenario
This activity is based on Accutime.
You are a management accountant working for Accutime and you report to Graham Anderson,
the chief financial officer (CFO).
At the last board meeting, it was stipulated that the minimum required return on all projects
for the coming year must be 18%.
The minutes from the meeting document discussions surrounding the continued intense
competition, exchange rates and the general malaise in the economies of Accutime’s key
markets as reasons for the 18% minimum return.
The minutes also record one director as stating: ‘The high return of 18% will ensure only the
best projects are accepted and enable us to provide the superior returns our shareholders
demand of us.’
Graham is unhappy with the board’s final decision of a minimum return of 18% and has
requested that a review be completed of Accutime’s WACC. Graham has stipulated that the
CAPM approach be used to estimate Accutime’s cost of equity.

ACT
Tasks
1. Determine Accutime’s weights of debt and equity for 2018.
2. Estimate Accutime’s WACC using the following information. (Calculate to one decimal
point based on book values.)
To determine the costs of each source of finance, you have identified additional information
that you will use to estimate Accutime’s WACC.
• Bank borrowing represents an interest-only, five-year bank term loan at a fixed 7.8%
interest rate until maturity, which was drawn down in January 2018 to help fund the
BACTech acquisition.
• A beta of 1.10, which is consistent with proprietary financial information sources that
estimate betas for listed companies.
• The market risk premium is between 4.5% and 7.0%. Based on your understanding of
the return required by the shareholders of Accutime, you decide to base your initial
WACC calculations assuming a market risk premium of 6.0%.
• The risk-free rate is 4.6%, and the company tax rate is 30%.
3. Re-estimate Accutime’s WACC using the market values of equity.

As you review your WACC analysis, you recall from your university studies that market
values are preferred to book values. You search the Australian Securities Exchange website
and find a summary trading information table for Accutime as at the close of market the
previous day.
Accutime Limited (ACT)
Trading information
Trading status Active Close price $1.20
Trades 13 High $1.23
Value $165,510 Low $1.16
Volume 132,925 Close bid $1.20
Shares issued 228,262,146 Close offer $1.21
4. Assess the implications of the board’s stipulated minimum return of 18% on new projects.

ACT
Solution
1. For 2018, the weight of debt is 8.9% and the weight of equity is 91.1%.
2. Accutime’s WACC is estimated at 10.7%.
3. Using the market value of equity, the WACC is also 10.7%
4. The possible implications of the board’s stipulated minimum return of 18% on new projects
and explanations of each are set out in the table.
Implications of the board’s stipulated minimum return of 18% on new projects
It may result in Accutime forgoing wealth-creating Projects earning more than the WACC but less than
investment opportunities the 18% minimum return demanded by the board will
be rejected
On average, Accutime could invest in higher As the board-stipulated return is substantially higher
risk projects, thereby changing its risk profile than the WACC for Accutime, this could mean, over
over time time, investing in higher risk projects, as higher return
projects are also likely to have a higher risk on average
Accutime could become less competitive and lose If the company is forgoing investment opportunities
market share that would otherwise be acceptable, competitors may
then pick up these projects, thereby increasing their
market share
The minimum return of 18% on all projects may For some very risky projects, an 18% return may,
be too low for some projects in fact, be lower than an appropriate risk-adjusted
minimum return for these projects
The following outlines the recommended approach for successfully completing the tasks.
Task 1
• The latest financial statements (provided in the case study) show that the value of long-term
interest-bearing debt is $24,000,000.
• You then note the book value of equity to be $245,960,000. Shareholders demand a return on
their entire investment, which includes past profits that have been reinvested on their behalf
by Accutime’s management.
• The weight of debt is estimated as: $24,000,000 ÷ ($24,000,000 + $245,960,000), or 8.9%.
For equity it is 91.1%, based on: $245,960,000 ÷ ($24,000,000 + $245,960,000).

ACT
Task 2
WACC (book values)
Item Weight After-tax cost Weighted cost
Debt 8.9% 5.5% 0.5%
Equity 91.1% 11.2% 10.2%
WACC 10.7%
• Cost of debt is based on the after-tax interest cost or 7.8% (1 – 0.3) = 5.5%.
• Cost of equity is estimated using the CAPM or ke = rf + βe(rm – rf ) = 4.6% + 1.10(6.0%) = 11.2%
Note that a common error in calculating the CAPM is to use the market risk premium (rm – rf ) as
market return rm. If this error had been made, the answer of 6.1% estimated for the cost of equity
would be incorrect. The market return is the total expected return on the market, whereas the
market risk premium represents the extra that the market expects to earn over and above the
risk-free rate.
• Weighted cost of debt is 8.9% × 5.5% = 0.5%.
• Weighted cost of equity is 91.1% × 11.2% = 10.2%.
• WACC of 10.7% is equal to 0.5% + 10.2%.
Task 3
WACC (market values)
Item Weight Cost Weighted cost
Debt 8.1% 5.5% 0.4%
Equity 91.9% 11.2% 10.3%
WACC 10.7%
Now you can re-estimate WACC using the market values of equity. As the debt is an interest-
only bank term loan denominated in Australian dollars, the current market value of the
loan is equal to its book value. Based on market information, the equity value in the WACC
calculation would therefore now change from $245,960,000 to $273,914,575 (228,262,146
× $1.20). This calculation is based on the closing price because this value equates to the latest
market valuation:
• The weight of debt is $24,000,000 ÷ ($24,000,000 + 1.20 × 228,262,146) = 8.1%.
• The weight of equity is 1.20 × $228,262,146 ÷ ($24,000,000 + 1.20 × 228,262,146) = 91.9%.
• Weighted cost of debt is 8.1% × 5.5% = 0.4%.
• Weighted cost of equity is 91.9% × 11.2% = 10.3%.
• WACC of 10.7% is equal to 0.4% + 10.3%.
Given that book values and markets values are very similar, there is only a marginal difference
(less than 0.1%) in WACC between book values and market values. Market values are, however,
considered a better estimate or proxy for the target capital structure of the organisation and are
therefore preferred ahead of book values.

ACT
Task 4
When reflecting on the WACC analysis, turn your attention to the implications of the
board’s decision to use an 18% minimum return on all projects. Consider whether 18% is
more appropriate (it will ensure only the best projects are accepted, and enable Accutime
to earn superior returns as demanded by the shareholders) or the WACC (as it represents
the risk‑adjusted return demanded by all providers of capital, including the shareholders).
The better response is that the WACC is more appropriate, as it represents the risk-adjusted
return demanded by all providers of capital, including the shareholders.

ACT
Activity 12.3
NPV and payback methods
Introduction
A limitation of the payback period method of project evaluation is that it ignores the time value
of money. To overcome this limitation, some organisations use the discounted payback period
method for capital investment decisions. The discounted payback period method is similar
to the payback period method except that it uses discounted cash flows when calculating
the payback period. Using this method, the accept–reject decision is made by comparing the
discounted payback period with the desired payback period.
• Apply capital budgeting techniques to assess investment decisions.
At the end of this activity you will be able to generate information to make an informed
potential investment decision by calculating the discounted cash flow and both the payback
and discounted payback periods.
Scenario
You are the senior management accountant in the head office of TightFitt, a large fitness group.
You report to the financial controller, Lara Lycra.
TightFitt currently owns and runs 25 gyms throughout Australia and New Zealand. Lara
informs you that the marketing department would like to add a climbing wall to the facilities
in each of its gyms, all of which have sufficient room to build this additional facility.
Based on a prototype created within one of the Adelaide gyms, the marketing department has
provided the following estimates for your use in analysing discounted cash flow, payback and
discounted payback periods. All price and cost estimates are exclusive of GST.
TightFitt – Climbing wall project estimates
Construction/set-up costs $200,000
Additional staff costs per annum $105,250
Equipment maintenance per annum 10% of construction cost
Additional annual memberships 75
Average annual membership fee $1,250
Number of members who would have left on expiry of membership, but 25

are now remaining with the gym on an ongoing basis’ because of the
installation of the climbing wall
Additional annual casual visits 75 per week
Casual visit charge $15
WACC 14%

ACT
TightFitt – Climbing wall project estimates
Equipment life Expected life of walls and

equipment is five years
Taxation TightFitt has substantial carried

forward tax losses and is not
expected to pay income tax for
10 years
Tax rate 30%
Tasks
1. Calculate the net present value of the climbing wall within one of TightFitt’s gyms.
2. Calculate the payback period.
3. Calculate the discounted payback period.
Based on each calculation, recommend whether TightFitt should proceed with the investment.

ACT
Solution
1. The net present value of the climbing wall in one of TightFitt’s gyms is calculated at –$86.
(Note 1: This NPV is calculated using the PV tables. If a financial calculator was used then
the answer would be –$23.03. The difference is due to rounding. Both answers would be
marked correct.) Therefore, based on this calculation alone TightFitt should not proceed
with the investment.
2. The payback period is 3.43 years, which is less than the five-year investment period.
Therefore, based on this calculation alone TightFitt should proceed with the investment.
3. The discounted payback period is not reached prior to the end of the investment period.
Therefore, based on this calculation alone TightFitt should not proceed with the investment.
Examining the conclusions for Tasks 1, 2 and 3 in combination, TightFitt should not proceed
with the investment as the superior discounted cash flow criteria reject the project.
Task 1
Step 1 – Prepare a table of discounted cash inflows and outflows for the
climbing wall
• According to the information in the table of price and cost estimates, the climbing wall
and equipment will last five years.
• The initial outlay is $200,000.
• The information in the table estimates 75 additional annual memberships. This means
that in every year of the project there will be 75 additional annual members who have
joined because of the installation of the climbing wall. When multiplied by the average
membership fee of $1,250, this amounts to a revenue increase of $93,750 per annum.
• The estimate for retained annual members is 25. This means that in every year of the project
there are 25 annual members who are retained because of the installation of the climbing
wall. When multiplied by the average membership fee of $1,250, this amounts to a revenue
increase of $31,250 per annum.
• Additional casual visitors are estimated at 75 per week. This means that for every week of
every year of the project there are 75 casual visitors who pay to climb the wall. At $15 per
visit for 52 weeks, this amounts to a revenue increase of $58,500.
• According to the information in the table, $105,250 is the estimate for additional staff costs
per annum.
• Equipment maintenance per annum is 10% of the construction cost of $200,000 (i.e. $20,000).
• Using the WACC of 14% as given in the information table, calculate the discounted
cash flow.
Note: When preparing the cash flow table only incremental cash flows are considered. There
are no depreciation shield adjustments in the table as, according to the facts in the scenario,
TightFitt is not expected to pay tax for 10 years and the project is five years in length.
Note that the table below has used the discount rate rounded to three decimal places.

ACT
TightFitt – Climbing wall project evaluation
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Initial outlay/construction ($200,000)
Cash inflows – revenue
Increased membership $93,750 $93,750 $93,750 $93,750 $93,750
Retained members $31,250 $31,250 $31,250 $31,250 $31,250
Casual visitors $58,500 $58,500 $58,500 $58,500 $58,500
$183,500 $183,500 $183,500 $183,500 $183,500
Cash outflows – costs
Additional staffing costs ($105,250) ($105,250) ($105,250) ($105,250) ($105,250)
Equipment maintenance ($20,000) ($20,000) ($20,000) ($20,000) ($20,000)
($125,250) ($125,250) ($125,250) ($125,250) ($125,250)

Cash flow ($200,000) $58,250 $58,250 $58,250 $58,250 $58,250
WACC discount factor (14%)* 1.000 0.877 0.769 0.675 0.592 0.519
Discounted cash flows ($200,000) $51,085 $44,794 $39,319 $34,484 $30,232
* The discount factor numbers used come from the PV table available from the resources section in the Candidate Study
Guide. The discount factor can also be calculated manually giving a small difference in the discounted cash flows due
1
to rounding using the formula ______
 
(1+r)n .
Step 2
The NPV of the project is the sum of the discounted cash flows (i.e. –$86). Generally, projects
with a positive NPV should be accepted and those with a negative NPV should be rejected.
As this project’s NPV is negative (it is marginally below break-even), it would be rejected.
Task 2
The project’s net cash flows are summarised in the following table:
Cash flows ($200,000) $58,250 $58,250 $58,250 $58,250 $58,250
This project requires an initial cash outlay of $200,000. After one year, the project has ‘paid back’
$58,250 of the $200,000. After two years, the project has paid back $116,500. After three years,
$174,750 has been paid back. This means that the payback point is reached somewhere during
the fourth year.
At the beginning of the fourth year, another $25,250 is required to be paid back and cash
flow of $58,250 is generated during the year. Thus, the payback period is three full years plus
a proportion ($25,250 ÷ $58,250) of the fourth year (i.e. the payback period is 3.43 years in
this case).

ACT
Task 3
The project’s discounted net cash flows are summarised in the following table:
Cash flows ($200,000) $58,250 $58,250 $58,250 $58,250 $58,250
Discount factor 14% 0.877 0.769 0.675 0.592 0.519
Discounted cash flows ($200,000) $51,085 $44,794 $39,319 $34,484 $30,232
This project requires an initial cash outlay of $200,000. After one year, the project has ‘paid back’
$51,085 of the $200,000. After two years, the project has paid back $95,879. After three years,
$135,198 has been paid back. After four years, $169,682 has been paid back. After five years,
$199,914 has been paid back.
This means that the payback point is not reached prior to the end of the project, and so, using
this evaluation method alone, the project would not proceed.
Note that this is identical to the signal from the NPV analysis, and the shortfall at the end of
Year 5 ($199,914 – $200,000) is equal to the NPV for the project (i.e. –$86).
Recall that the standard undiscounted payback approach determined that payback would occur
in 3.43 years. Management would need to reconcile the conflicting signals from this standard
payback analysis versus the NPV and discounted payback analyses. Qualitative factors could
also be relevant to any decision.

ACT
Activity 12.4
Errors in capital budgeting calculations
Introduction
In any organisation, capital investment decisions are significant as they need to maximise the
entity’s future returns, maintain competitive advantage and align with its strategic direction.
As the amount of capital involved can be significant, a poor investment decision can have a
negative impact on results for a number of years. Therefore, it is important for management of
an organisation to critically assess the various investment opportunities available. This includes
considering both the quantitative and qualitative factors influencing an investment decision.
• Assess behavioural influences, as well as other qualitative issues that impact on investment
decision-making.
At the end of this activity you will be able to recommend whether to proceed with an
investment opportunity based on a net present value (NPV) calculation and a payback
calculation, as well as identify the qualitative factors influencing the decision.
Scenario
You are the senior management accountant within the head office of B Limited, an import and
distribution business. You report to the financial controller, Barry Bringit.
B Limited is currently renting a warehouse for use in its import and distribution business. The
company currently has surplus cash of $2,500,000, and it has been told that it could build a
warehouse equivalent to the rented one, thus saving future costs and, ultimately, making the
business more profitable.
The following NPV has been prepared to assist in analysing the proposal.
Year 0 1 2 3 4 5
$’000 $’000 $’000 $’000 $’000 $’000
Cost of warehouse (2,500.0)
Disposal value
Lease cost 85.0 85.0 85.0 85.0 85.0
Other operating costs (10.0) (10.0) (10.0) (10.0) (10.0)
Net cash impact (2,500.0) 75.0 75.0 75.0 75.0 75.0
Tax effect at 30% (22.5) (22.5) (22.5) (22.5) (22.5)
After tax cash flow (2,500.0) 52.5 52.5 52.5 52.5 52.5
Discount rate 1.000 0.909 0.826 0.751 0.683 0.621
Net cash flows (2,500.0) 47.7 43.4 39.4 35.9 32.6
Net present value (2,301.0)

ACT
Barry has also provided you with the following additional information to use in analysing the
proposal prepared by the production manager:
A. The period of five years represents the lease period applicable to the current rental
agreement renewal for the warehouse.
B. Other operating costs represent the extra annual costs that will be incurred if B Limited
builds its own warehouse.
C. It is currently unknown what B Limited would do with the building after five years, but one
possibility is to sell it. The estimated selling price would be $1.250 million.
D. B Limited has been told that depreciation of $250,000 per year would be available for the
company to use for additional tax deductions.
E. B Limited’s current WACC is 14.0%.
Note: The discount rate figures have been obtained from the PV table located at the beginning
of the CSG.
Tasks
1. Identify the obvious errors or omissions in the NPV calculation as presented.
2. Identify the qualitative issues that may affect the decision to build the warehouse.
3. Recalculate the NPV calculation correctly.
4. Based on the available information calculate the payback period for building the
new warehouse.
5. Based on all of the above information, state whether you would accept the proposal or not.

ACT
Solution
1. Errors or omissions in the NPV calculation include:
• The cash receipt for the sale should be included in Year 5.
• There is no depreciation tax shield shown.
• The discount rate should use the WACC, not 10%.
2. Qualitative issues include:

• What else would or could B Limited do with the spare cash?
• What is the long-term strategy for the company, especially after the 5-year period?
• What is the location of new warehouse (i.e. logistics)?
• Is the capacity of the warehouse likely to meet the company’s needs longer term
(or would it have excess capacity)?
3.
Year 0 1 2 3 4 5
$’000 $’000 $’000 $’000 $’000 $’000
Cost of warehouse (2,500.0)
Lease cost1 85.0 85.0 85.0 85.0 85.0
Other operating costs (10.0) (10.0) (10.0) (10.0) (10.0)
Net cash impact (2,500.0) 75.0 75.0 75.0 75.0 75.0
Tax effect at 30% (22.5) (22.5) (22.5) (22.5) (22.5)
Depreciation shield2 75.0 75.0 75.0 75.0 75.0
Sale proceeds 3
1,250.0
After tax cash flow (2,500.0) 127.5 127.5 127.5 127.5 1,377.5
Discount rate 14% 1.000 0.877 0.769 0.675 0.592 0.519
Net cash flows (2,500.0) 111.8 98.1 86.1 75.5 714.9
Net present value (1,413.6)
Notes:
1. The lease cost represents the savings that the company would make from not having to rent a warehouse, and
therefore it is represented as a cash inflow.
2. Depreciation tax shield has been calculated on a net basis, i.e. $250,000 × 30% = $75,000.
3. Book value is $2,500,000 – (5 × $250,000) = $1,250,000. As this equals the proceeds on disposal there is no tax
impact.
4. This project requires an initial cash outlay of $2,500,000. After one year, the project has ‘paid
back’ $127,500 of the $2,500,000. After two years, the project has paid back $255,000. After
three years, $382,500 has been paid back. At the conclusion of the project $1,887,500 has been
paid back which is less than the initial cash outlay.
5. The project should be rejected as the NPV calculated in Task 3 is negative and at the
conclusion of the project the amount paid back is less than the initial cash outlay as per
Task 4. The qualitative issues in Task 2 should also be considered.

ACT
Task 1
To identify the obvious errors or omissions, apply your knowledge of NPV calculations to the
calculation presented. Compare with standard NPV calculation line items. Reference to other
activities and the worked example in this unit that include NPV calculations may assist you
with this process.
Task 2
The term ‘qualitative issues’ is explained in the CSG content of this unit, together with
examples. These examples should only be used where they are appropriate to the scenario.
Task 3
Taking into consideration the errors and omissions you identified in Task 1, recalculate the NPV
correctly.
Note: Responses may vary slightly from the one provided due to rounding, depending
on whether PV tables or a formula has been used to determine the discount factor.
Task 4
An example of how to calculate the payback period can be found within the CSG content
of this unit.
Task 5
Using the decision criteria contained in the CSG content for this unit, consider your answers for
Tasks 2, 3 and 4, and make your determination. Then state clearly whether you would accept
the proposal or not.

ACT
Activity 12.5
Investment decisions
Introduction
The objective of this activity is to highlight common mistakes or pitfalls when creating
discounted cash flow models.
The activity links to unit learning objectives:
• Assess investment decisions by performing sensitivity analysis.
• Assess behavioural influences, as well as other qualitative issues that impact on investment
decision-making.
At the end of this activity you will be able to evaluate a capital investment project using
incremental cash flow analysis in a real-world setting. You will also be able to provide guidance
on additional considerations and alternative approaches that may assist with the analysis of
the project.
Scenario
This activity is based on Accutime Limited.
Sam Lewis has a business internship with Accutime Limited (Accutime) during the summer
university break, and you have been given the task of overseeing Sam’s work. You have decided
that Sam should construct a discounted cash flow model to analyse a new packaging system at
the Reading (UK) plant.
As production has increased over recent years, the existing packaging system has struggled to
cope. This is creating a bottleneck and has resulted in increased levels of work-in-progress and
finished goods inventories on hand. Overall, Accutime expects the new system to improve the
Reading plant’s delivery capacity. This would improve the profit contribution by $1,580,000 per
annum. Other changes (not included in profit contribution) include annual salary savings of
$78,000 and an immediate $300,000 reduction in inventories.
The purchase price of the assembly system is $2,000,000 and it will cost $100,000 to install. The
entire cost will be financed with a bank term loan at an interest rate of 7.9% per annum. The
new system could be sold for $320,000 at the end of Year 4. The tax authority allows 15% prime
cost (straight line) depreciation on assembly lines and the same rate would be used for financial
accounting purposes. All figures are in Australian dollars. The Accutime board has declared that
it will only accept projects where the net present value (NPV) exceeds an 18% return.
Accutime’s organisation-wide effective tax rate is 30%.

ACT
Sam has forwarded her summary of relevant cash flows to you for review:
Summary of relevant cash flows
Item Year 0 Year 1 Year 2 Year 3 Year 4

$ $ $ $ $
Total cost of asset (2,100,000)
Net working capital (300,000)
Increased profit contribution 1,580,000 1,580,000 1,580,000 1,580,000
Plus: Salary savings 78,000 78,000 78,000 78,000
Less: Interest expense 165,900 165,900 165,900 165,900
Less: Depreciation 200,000 200,000 200,000 200,000
Net profit before tax 1,292,100 1,292,100 1,292,100 1,292,100
Less: Tax 387,630 387,630 387,630 387,630
Net profit after tax 904,470 904,470 904,470 904,470
Proceeds from sale of asset 320,000
Project’s net cash flow (2,400,000) 904,470 904,470 904,470 1,224,470
Tasks
1. Analyse Sam’s summary of relevant cash flows to identify the line items that you think
should be checked and/or corrected.
2. Using this analysis, create a revised incremental cash flow analysis.
3. Identify potential alternative methods for analysing the financial performance of the project.
Indicate which of these would be appropriate if Accutime is not interested in the time value
of money when making its capital budgeting decisions, and create another summary of
relevant cash flows to illustrate additional analysis.
4. Identify the additional qualitative, quantitative and behavioural issues that may impact the
decision to proceed with the investment.
5. Perform a sensitivity analysis to determine the impact of a 10% increase and 10% decrease
in profit contribution. Recalculate the NPV based on these two adjustments using the same
cash flow format used in the previous steps.

ACT
Solution
1. The following table shows an analysis of the line items from Sam’s summary of the relevant
cash flows that need to be checked and/or corrected.
Line item Analysis
Net working capital (NWC) Should be shown as a cash inflow in Year 0 as it represents a reduction in
investment in inventory
Should be shown as a cash outflow in Year 4 as NWC changes are reversed
at the end of the project’s life
Interest expense Interest expense should not be included in the operating cash flows
as it is included in the weighted average cost of capital (WACC) when
determining NPV
Depreciation The depreciation rate should be based on the maximum rate allowed by the
tax authorities
Depreciation should be calculated on the asset’s original cost plus
installation costs
Depreciation is added back to net profit after tax in order to estimate net
operating cash flows
Proceeds from sale of asset The resale value of the asset should be net of any tax impact arising on sale
Required rate of return The board has decreed that 18% will be the minimum required
2. Based on the analysis from Task 1, the incremental cash flow analysis should look like this:

$ $ $ $ $
Net working capital* 300,000 (300,000)
Income before tax 1,343,000 1,343,000 1,343,000 1,343,000
Less: Tax 402,900 402,900 402,900 402,900
Plus: Depreciation 315,000 315,000 315,000 315,000
Net operating cash flow after tax 1,255,100 1,255,100 1,255,100 1,255,100
Net proceeds from sale of asset 476,000 †
Project’s net cash flow (1,800,000) 1,255,100 1,255,100 1,255,100 1,431,100
Discount factor (18%) 1.000 0.847 0.718 0.609 0.516

Discounted cash flow (1,800,000) 1,063,070 901,162 764,356 738,448

NPV 1,667,036

ACT
A positive NPV indicates that the project should be accepted pending analysis of qualitative
issues.
* Represents the cash freed up in inventory. A saving in a cash outflow is the same as a cash inflow. The amount in
Year 4 represents the effect being reversed as inventories go back to normal levels at the end of the project.
† The net proceeds from the sale of the asset are calculated as follows:
Tax from sale of asset in Year 4
Original cost 2,100,000
Less: Accumulated depreciation ($315,00 × 4) 1,260,000
Adjusted tax value 840,000

Sale price (salvage value) 320,000
Less: Adjusted tax value 840,000
Depreciation recovered (loss on sale) (520,000 )
Tax to pay (benefit) on sale ($520,000 × 30%) (156,000 )
Net proceeds ($320,000 + $156,000) 476,000
3. Alternative methodologies for analysing the financial performance of the project could
include:
• Internal rate of return (IRR).
• Accounting rate of return (ARR).
• Payback.
Of these, only payback and ARR on investment would be appropriate if Accutime were not
interested in the time value of money when making its capital budgeting decisions.
Internal rate of return

You can now provide additional analysis that will enhance the decision-making process
by providing alternative methods to assess the financial impact of the investment decision
as follows:

ACT

$ $ $ $ $
Net working capital 300,000 (300,000)
Less: Tax 402,900 402,900 402,900 402,900
Net proceeds from sale of asset 476,000
Discount factor (18%) 1.000 0.847 0.718 0.609 0.516

NPV 1,667,036
IRR using the Excel calculator 60.0%
Accounting rate of return

In year 4 there is a loss on sale, this needs to be incorporated into the average profit after tax
figure, so the following adjustment needs to be made:
Average profit after tax = [($940,100 × 3 years) + ($940,100 – loss on sale + tax benefit)] / 4 years
= [($940,100 × 3 years) + ($940,100 – $520,000 + $156,000)] / 4 years
= $849,100
ARR = 70.17% ($849,100/ $1,210,000)
Average investment = ($2,100,000 + $320,000) ÷ 2 (representing 2 time periods)
= $1,210,000

ACT
Payback period
Year Initial Cash Investment Unrecovered initial Years
Investment Inflow recouped investment expired
$ $ $ $
0 (1,800,000) 0 0 (1,800,000)
1 1,255,100 1,255,100 (544,900) 1
2 1,255,100 544,900 0 0.43
Payback period 1,800,000 1.43
From the calculation Sam notes that the IRR (60.0%) and the ARR (70.17%) are both in excess
of the required rate of return of 18%. In addition, the payback period is less than two years.
All of these metrics suggest that the project should be accepted.
4.
Issues table
Issue Qualitative/quantitative/behavioural?
Staff morale Qualitative
Impact of inflation Quantitative
Do we really need the packaging system at Reading or is it just Behavioural

the desire of the manager?
Will the tax rates remain the same for the life of the project? Quantitative
What is the board’s real risk profile and can it be influenced for Behavioural
this decision?
Is there space for the new packaging system? Qualitative
5. The 10% increase would result in an NPV calculation as follows:
Accutime – New packaging system
Data section $ Data section $
Total cost of asset 2,100,000 Resale value 320,000
Increased profit contribution 1,738,000 Change in net working capital 300,000
Salary savings 78,000 Depreciation rate (SL) 15.0%
Sensitivity section Corporate tax rate 30%
Profit contribution sensitivity increase 10% Required return 18.0%
Cost of debt 7.9%

ACT

$ $ $ $ $
Total cost of asset (2,100,000 ) (300,000)
Net working capital 300,000
Less: Tax 450,300 450,300 450,300 450,300
Net profit after tax 1,050,700 1,050,700 1,050,700 1,050,700
Discount factor (18%) 1.000 0.847 0.718 0.609 0.516
NPV 1,964,549
The 10% decrease would result in an NPV calculation as follows:
Accutime – New packaging system
Data section $ Data section $
Total cost of asset 2,100,000 Resale value 320,000
Decreased profit contribution 1,422,000 Change in net working capital 300,000
Salary savings 78,000 Depreciation rate (SL) 15.0%
Sensitivity section Corporate tax rate 30%
Profit contribution sensitivity decrease (10%) Required return 18.0%
Cost of debt 7.9%

ACT

$ $ $ $ $
Net working capital 300,000 (300,000)
Profit contribution 1,422,000 1,422,000 1,422,000 1,422,000
Less: Tax 355,500 355,500 355,500 355,500
Discount factor (18%) 1.000 0.847 0.718 0.609 0.516
Discounted cash flow (1,800,000) 969,392 821,751 697,001 681,378
NPV 1,369,522
As the NPV remains positive under both sensitivity analysis scenarios, the project should be
accepted.

ACT
Task 1
To identify line items that need to be checked and/or corrected, apply your knowledge of NPV
calculations to the summary of relevant cash flows presented. Compare with standard NPV
calculation line items. Reference to other activities and the worked example in this unit that
include NPV calculations may assist you with this process.
Task 2
Taking into consideration the items to be checked and/or corrected from Task 1, create a
revised incremental cash flow, concluding with a NPV for the project. Using only NPV
decision criteria contained in the CSG content for this unit, determine whether Accutime
should accept the project.
Task 3
Referring to the CSG content, identify possible potential alternative methodologies. Then
determine which methodologies do not consider the time value of money. Having correctly
identified payback and accounting rate of return as the methodologies to use if Accutime were
not interested in the time value of money, apply them and the other alternative methods to
Accutime’s capital budgeting decision to provide additional analysis.
Use the examples in the CSG content of this unit to help you apply the alternative
methodologies. Using the decision criteria contained in the CSG content, and based on your
analysis of each methodology, conclude on whether Accutime should accept this project.
Task 4
The distinction between quantitative and qualitative issues, and the meaning of behavioural
issues, are explained in the CSG content of this unit, together with examples. These examples
should only be used where they are appropriate to the scenario.
Task 5
First, by increasing the profit contribution by 10%, recalculate the incremental cash flow
analysis. Then record the revised NPV. Repeat this process using a 10% reduction in the profit
contribution. Conclude on the results of the sensitivity analysis.

ACT
Unit 13: Business valuations
Activity 13.1
Market-based valuation
Introduction
With the market-based approach, the value of a business is determined by benchmarking it
against the value of comparable organisations. This activity uses the market-based method of
valuation and links to the following unit learning objectives:
• Summarise the income, market and cost valuation methodologies, and explain their
respective strengths and weaknesses.
• Prepare valuations using both the income and market approaches.
At the end of the activity you will be able to calculate the valuation of an organisation using the
market based approach.
Scenario
Last month Rod Group Limited (Rod Group), which is listed on the New Zealand Stock
Exchange (NZX), announced its intention to acquire Nepal Limited (Nepal), which is listed
on the Australian Securities Exchange (ASX) and specialises in selling outdoor clothing
and equipment in Australia. Rod Group’s homeware and sporting goods retail businesses
operate throughout New Zealand, and the acquisition of Nepal is seen as an opportunity to
access a new market. Rod Group has offered to acquire all the shares in Nepal at A$1.40 per
share. This represents a A$0.15 premium on the last traded price immediately prior to the
takeover announcement.
Nepal’s board of directors have since received an independent valuation of Nepal using
the income-based valuation method. This independent valuation has been disseminated to
shareholders along with the board’s recommendation to accept Rod Group’s offer of A$1.40 per
share, which is at the bottom end of the independent valuation’s range.
The independent advisor’s base case discounted cash flow (DCF) enterprise value (EV) of
Nepal was A$157 million. After deducting A$36 million in long-term debt and dividing by
the 79 million shares on issue, a fair market value of A$1.53 per share was obtained. However,
based on sensitivity analysis of Nepal’s WACC and terminal growth rate, the independent
fair market valuation range is A$1.40–A$1.65 per share. The table below, extracted from the
independent advisor’s report, highlights this valuation range under the current WACC of 7.7%
and various terminal growth rate scenarios:
maaf12113_act_01

ACT
WACC Terminal growth rate
(%) 1.75% 2.00% 2.25%
7.5 $1.54 $1.68 $1.83
7.6 $1.47 $1.60 $1.73
7.7 $1.40 $1.53 $1.65
7.8 $1.33 $1.45 $1.57
7.9 $1.28 $1.39 $1.49
Joan and Jonathan Stokes own 10.6% of Nepal, and while they are happy with the independent
valuation range, they disagree with the directors’ recommendation to accept a price at the
bottom end of this range. You are the personal accountant for Joan and Jonathan, and they have
asked you to conduct alternative valuations and advise them as to whether they should accept
the offer of A$1.40 per share.
To help you conduct market-based valuations, you have collated the following information
for Nepal and comparable retail companies. In Nepal’s most recent financial statements, its
earnings before interest, taxes, depreciation and amortisation (EBITDA) was A$31.4 million and
reported net profit after tax was A$14.3 million.
Comparable company Company equity Price/earnings (P/E) EV/EBITDA multiple

(A$ million) multiple
Base Camp Limited 139 6.7 5.2
Great Outdoors 1,360 12.2 7.9
Lands Recreational 235 8.1 5.0
Maxipacs Holdings 112 7.3 4.6
Sports-R-U 98 8.8 5.4
Your World Group 2,698 13.1 8.9
First, using a simple average of all six comparable firms, you estimate Nepal’s value as A$1.70
per share using the market-based P/E method. Second, you rework your analysis by excluding
Great Outdoors and Your World Group, which are substantially larger than Nepal, and re-
estimate the P/E based valuation at A$1.40 per share.
Tasks
(a) Calculate Nepal’s equity value based on both Rod Group’s offer price and Nepal’s share
price immediately prior to the offer. Show all workings.
(b) Calculate two (2) share price estimates using the market-based EV/EBITDA method.
The first estimate should use an average multiple for all comparable companies, and the
second estimate should exclude the two largest companies. Show all workings.
(c) Discuss why size is important when selecting appropriate comparable companies.
(d) Recommend whether or not Joan and Jonathon Stokes should accept Rod Group’s current
offer. Justify your recommendation.

ACT
Solution
(a)
Equity value of Rod Group offer: $1.40 × 79,000,000 = $110,600,000
Equity value of current market share price: ($1.40 − $0.15) × 79,000,000 = $98,750,000
(b)
Share price estimates (two (2) required):
All firms Similar sized firms

$ $
EBITDA 31,400,000 31,400,000
Multiple 6.17
1
5.052
Enterprise value 193,738,000 158,570,000
Less: Debt 36,000,000 36,000,000
Equity value 157,738,000 122,570,000
Share price 2.00 1.55
Note:
1. (5.2 + 7.9 + 5.0 + 4.6 + 5.4 + 8.9) ÷ 6 = 6.17.
2. (5.2 + 5.0 + 4.6 + 5.4) ÷ 4 = 5.05.
(c)
There is a difference in risk between small and large companies. Larger firms may have a greater
level of diversification through targeting a larger of number of markets and geographic areas, and
have better economies of scale, creating a lower risk profile. As such, investors demand a premium
(higher) return for smaller firms. The premium (higher) return lowers small firm values.
Smaller firms typically have lower marketability and/or liquidity than larger firms even when
they are quoted and traded on the same stock exchange.
(d)
A recommendation to either accept or reject the Rod Group offer was accepted as equally valid
(although there is more supporting evidence for rejecting the offer and holding out for a value
closer to the mid-point (expected) discounted cash flow (DCF) range). A recommendation
must be supported by appropriate scenario-related evidence that is consistent with the
recommendation. For example:
Recommendation: Accept offer of $1.40 per share Recommendation: Reject offer of $1.40 per share
$1.40 is (just) within the DCF range of $1.40−$1.65 $1.40 is at the very bottom of the independent
advisor’s DCF valuation range
Nepal’s price−earnings (P/E) valuation based on Nepal’s EV/EBITDA valuation based on similar-sized
similar-sized comparable firms is $1.40 per share comparable firms is $1.55 per share, which is closer to
the mid-point (expected) DCF valuation of $1.53
Offer is $0.15 per share (or 12%) higher than market EV/EBITDA method has a number of potential
price at time of offer advantages over the P/E approach. For example, it more
closely approximates cash flows, is not distorted by the
different financing/capital structures of the comparable
firms, and focuses on operating performance
The mid-point (expected) DCF valuation is

$1.53, which is 9% higher than the current offer.
This difference equates to an additional $1,088,620 for
Joan and Jonathan Stokes

ACT
Activity 13.2
Business valuation using income and market
based approach
Introduction
This is an integrated activity combining the topics of weighted average cost of capital (WACC),
capital structure decisions and business valuations. For this activity you are required to
calculate WACC, discuss differences of two different organisation’s betas, prepare an income
based valuation and identify limitations of a market-based valuation for a specific scenario.
Unit 12
• Calculate and apply weighted average cost of capital (WACC) .
Unit 13
• Prepare valuations using both the income and market approaches. .
Unit 15
• Apply the major theories and practical tools to the evaluation of capital structure decisions..
Scenario
Founded four (4) years ago, QTR Gaming Ltd (QTR) develops electronic entertainment gaming
products. The company has grown rapidly as the result of its globally popular game ‘Action
Matt’, with current sales exceeding 5 million copies. As the sequel to Action Matt is approaching
its release date, QTR’s board is considering a public listing on the Australian Securities
Exchange (ASX).
The company has compiled the following information to be used in the valuation process:
Extract from the current year’s balance sheet
Liabilities
Long term loan, 8% p.a. $2,500,000
Equity
Ordinary shares ($1 par) $5,000,000
Other information
• 10-year Commonwealth bonds rate: 4.25% p.a.
• Market risk premium: 6.5% p.a.
• Griffon Gaming Ltd (GGL) is a gaming company offering products similar to QTR’s. GGL
is ASX-listed with a market value of $20 million equity and a beta of 1.63. GGL is financed
with $20 million in market value of debt.

ACT
• The advising investment bankers expect the ordinary shares of QTR to have a total market
value of $7.5 million once the company lists on the ASX.
• The company tax rate is 30%.
Part A
Task
(a) Calculate the weighted average cost of capital (WACC) for QTR after the proposed listing.
(b) Based on your calculation in (a) above, discuss the difference between the geared beta of
GGL and QTR.
Part B
As part of the work being done to evaluate the proposed public listing of QTR, you are asked to
prepare a valuation of the company. You gather the following information:
• The company tax rate is 30%.
• Current WACC is 8%.
• Free cash flow in the current year is $460,500.
• Free cash flow is forecast to grow at 12% p.a. for the next three (3) years.
• After three (3) years, QTR’s cash flow is forecast to grow at 2.5% p.a.
Tasks
(a) Calculate the enterprise value of QTR using an income-based approach.
(b) Using the enterprise value calculated in (a) above, determine the equity value of QTR.
Part C
Michelle Browne, a junior member of QTR’s accounting department, suggests it would be more
appropriate to value QTR using a market-based approach such as EV/EBITDA multiple, rather
than an income-based approach. Michelle has gathered the EV/EBITDA figures for various well-
known publicly-listed companies in the entertainment industry:
Company Business EV/EBITDA
Game Machines Ltd Gaming hardware 10.42
Omega Game Store Ltd Online gaming retailer 40.67
Mattchmovies Ltd Online entertainment 12.66
Machine Mad Ltd Gaming hardware 10.84
Average 18.65
On the basis of these figures Michelle suggests a valuation of $17,158,000 [calculated as 18.65 ×
$920,000 (current EBITDA)] would be appropriate for QTR.
Tasks
Identify and explain two (2) key limitations with a market-based approach to valuing QTR.
Justify your response.

ACT
Solution
Part A
(a) Calculation of WACC for QTR after proposed listing
Ungeared beta of GGL
βU = βG / ;1 + ^1 - tc ha D kE
E
20,000,000
βU = 1.63/ ;1 + ^1 - 0.30hc
20,000,000 mE
βU = 0.96
Equity beta of QTR
βG = βu ;1 + ^1 - tc ha D kE
E
2,500,000
βG = 0.96 ;1 + ^1 - 0.30hc
7,500,000 mE
βG = 1.18
Cost of equity for QTR
ke rf G ^rm rf h
= 0.0425 + 1.18 (0.065)

= 0.1192 or 11.92%
WACC for QTR
WACC (proposed) Market value Weight Before tax cost After tax cost WACC
Debt $2,500,000 25% 8.00% 5.60% 1.40%
Equity $7,500,000 75% 11.92% 11.92% 8.94%
WACC $10,000,000 10.34%
(b) Difference between the geared beta of GGL and QTR

• GGL is more highly geared, hence its beta is higher (1.63 versus 1.18).
• The higher beta of GGL reflects greater risk when compared with QTR.
• The betas for both companies are greater than 1 therefore, they both have more
systematic risk than the market.

ACT
Part B
(a), (b) Calculation of the enterprise and equity value of QTR using an income-based approach
Current Year 1 Year 2 Year 3
$ $ $ $
Free cashflow 460,500 515,760 577,651 646,969
Terminal value 12,057,150
Total FCF 515,760 577,651 12,704,119
Discount factor 8% 0.926 0.857 0.794
Enterprise value 11,059,711 477,594 495,047 10,087,070
Value of debt 2,500,000
Equity value 8,559,711
Calculate the terminal value of QTR
FCFN ^1 g h
Terminal valueN
WACC g
$646, 969 # ^1.025h

= 0.08 - 0.025
= $12,057,150
Part C
Key limitations with a market‑based approach to valuing QTR. Two (2) limitations were required.
Issue Justification
Selection of comparable companies QTR is an early-stage company that develops electronic

entertainment gaming products. While the publicly listed companies
selected for comparison are all in the ‘entertainment’ space, their
activities differ quite considerably. Therefore, the risk of these
companies is likely to be significantly different from that of QTR and,
for this reason, they are likely to be very poor proxies
The average EV/EBITDA ratio given Without Omega Game Store Ltd in the list, the average of the
in the table is strongly influenced by remaining companies is 11.31, which, if used in the valuation, would
the extremely high ratio of 40.67 for result in an enterprise value of $10,405,200 (11.31 × $920,000).
Omega Game Store Ltd This enterprise value is much closer to the value calculated using the
income-based valuation technique (of $11,059,711) than Michelle’s
valuation of $17,158,000
The EV/EBITDA ratio of GGL has not GGL has been used as a proxy for beta in Part A. It may be more
been used appropriate to use the EV/EBITDA ratio for GGL too, as opposed to
those of the companies listed in the background
Historical earnings figures are often QTR’s historical earnings are a poor indicator as the company was
a poor indicator of future cash flow founded four years ago and has grown rapidly. Further, with the
performance, the true driver of value release of the sequel to Action Matt, future earnings are not likely to
be a reflection of those of the past
By taking only one year’s worth of With the release of games at different times, the earnings of QTR are
earnings (usually the most current), based on irregular business cycles
the cyclical nature of the business
is ignored

ACT
Unit 14: Short-term and medium-term

financial management
Activity 14.1
Lease versus buy decisions
Introduction
Lease versus buy decisions involve analysing the incremental cash flows and determining the
best alternative for each decision based on quantitative analysis. Before making a final decision,
the management accountant will also assess the qualitative aspects.
• Outline the nature and features of medium-term finance.
At the end of this activity you will be able to make decisions on whether to lease or buy
equipment using quantitative analysis.
Scenario
You are a management accountant at Accutime reporting to Graham Anderson, the chief
financial officer (CFO).
Accutime needs to invest in extra capacity at its Sydney plant, and an additional Sakikawa SX
robot is required to achieve this objective. The board of directors have already approved the
required $1 million investment in the robot, which is to be installed in unutilised space within
the clean room.
It has been established that the robot could be entirely financed by drawing down an existing
bank loan facility at an annual interest cost of 7.8%.
Three of the largest and most reputable finance companies that provide capital equipment
leases have been contacted, but unfortunately two of them have declined to offer a lease due to
their lack of knowledge of such specialised equipment. This has resulted in only one lease offer
to compare with the bank loan facility.
The terms of the lease include annual lease payments of $205,000 due at the beginning of each
year, for five years. Under this particular lease, there is no option for Accutime to purchase the
asset at the end of the lease term, as ownership remains with the leasing company. In contrast,
under the terms of the loan facility agreement, Accutime would own the robot outright at the
end of five years.
Additional costs directly related to the acquisition of the robot include electricity costs of up to
$50,000 per annum and 1.5 extra full-time salaried positions at an annual cost of $165,000. There
would also be an estimated immediate increase in net working capital of $170,000. The salvage
value of the Sakikawa SX robot is expected to be $225,000 at the end of five years. The allowable
maaf12114_act_01

ACT
depreciation rate for tax purposes is 12.5% using the prime cost (straight-line) depreciation
method and the effective company tax rate is 30%.
Task
For this activity you are required to determine whether the Sakikawa SX robot should be
financed by a lease or bank loan facility.

ACT
Solution
Buying the Sakikawa SX robot, rather than leasing it, is the most economical option as the
analysis shows a negative NPV.
The steps outline a recommended approach for successfully completing this task.
Step 1 – Select relevant data

The first step is to decide which of the cash flows is relevant to analyse in the context of the
lease versus buy decision. Remember that we are only interested in analysing cash flows that
are incremental to the decision.
Data relevance
Data item Relevant? Feedback
Cost of robot of $1,000,000 Yes This is the initial acquisition cost under the buy option. This cash
outflow would be avoided under the lease option and a saving in
a cash outflow is considered a cash inflow for the purposes of our
analysis. It is therefore an incremental cash flow and is relevant to
the decision
Electricity costs of up to No This cash outflow occurs irrespective of whether the robot is leased
$50,000 p.a. or bought. That is, there is no difference in the cash flows between
the two alternatives. It is therefore irrelevant to the analysis
Salvage value of $225,000 Yes Under the buy option, this cash flow would be realised by Accutime.
Under the lease option, the ownership of the asset and the rewards
associated with resale remain with the lessor
Tax depreciation rate of Yes Accutime will forgo the depreciation tax shield if it decides to go
12.5% with the lease option. The depreciation tax shield represents an
incremental net cash inflow and is therefore relevant to the decision
Lease payment of Yes Lease payments are incurred only with the lease option. They are
$205,000 p.a. incremental cash outflows and are therefore relevant to the analysis
Increased salary costs of No This cash outflow occurs irrespective of whether the robot is leased
$165,000 p.a. or bought. That is, there is no difference in the cash flows between
the two alternatives. It is therefore irrelevant to the analysis
Net working capital No This cash flow occurs irrespective of whether the robot is leased or
increase of $170,000 bought. That is, there is no difference in the cash flows between the
two alternatives. It is therefore irrelevant to the analysis
Bank loan facility – interest Yes This rate is used to calculate the after-tax financing cost for
rate of 7.8% p.a. discounting the relevant cash flows and is relevant to the decision
Effective company tax rate Yes The company tax rate is needed to analyse the cash flows on a
of 30% post‑tax basis and is relevant to the decision

ACT
Step 2 – Calculate the lease versus buy relevant cash flows

The next step is to analyse the relevant cash flows over the lifetime of the financing agreement.
At this stage it is critically important to be clear as to which perspective you are taking. The
analysis below is carried out from the perspective of using the lease. The incremental cash
flows for leasing the Sakikawa SX robot rather than purchasing it using the bank facility are
as follows:
Summary of relevant cash flows leasing perspective

$ $ $ $ $ $
Investment cost not 1,000,000

incurred1
Lease payments2 (205,000) (205,000) (205,000) (205,000) (205,000)
Tax benefit from lease 61,500 61,500 61,500 61,500 61,500

payment3
Tax benefit forgone (37,500) (37,500) (37,500) (37,500) (37,500)

(depreciation)4
Salvage value forgone5 (225,000)
Tax benefit forgone (45,000)

(salvage value)5
Net benefits 795,000 (181,000) (181,000) (181,000) (181,000) (246,000)
Notes
1. Recall that the table shows the incremental cash flows for leasing versus buying, and so by leasing the robot
Accutime does not need to pay the purchase price of $1,000,000. Therefore, this is an effective cash inflow of this
amount.
2. Lease repayments are a cash payment at the beginning of the year (i.e. in advance). However, the normal assumption
is that the tax benefits associated with the lease would not be recognised until the following year.
3. The tax benefit from lease payments, because the cash payments are tax deductible, is the lease payment multiplied
by the effective tax rate of 30% (i.e. $205,000 × 30% = $61,500).
4. The tax benefit forgone relating to depreciation (the depreciation tax shield) is the depreciation claimable in each
year as a tax-deductible expense multiplied by the effective tax rate of 30% (i.e. $1,000,000 × 12.5% = $125,000
depreciation claimable, and therefore the depreciation tax shield is $125,000 × 30% = $37,500).
5. Recall that the table shows the incremental cash flows for leasing versus buying, and so by leasing the robot
Accutime does not receive the salvage value of $225,000.
6. Cash flows related to financing the purchase option (loan advance and repayment, interest payments) are not
included in these cash flows as they are incorporated in the discount factor.
The tax benefit from the salvage value forgone is calculated as follows:
Original cost of robot 1,000,000
Less: Accumulated depreciation (5 × $125,000) 625,000
Book value for tax purposes 375,000
Salvage value 225,000
Less: Book value 375,000
Depreciation recovered (loss on salvage value) (150,000)
Tax to pay (benefit on salvage value) on sale (45,000)
An alternative presentation in the table is on a net basis: (225,000): + (45,000) = (270,000).

ACT
Step 3 – Complete the NPV calculation

As cash flows have been identified post-tax, an after-tax cost of financing needs to be applied
to them in order to calculate NPV. The headline interest rate of 7.8% is always quoted gross
of tax benefits, and so it needs to be adjusted before the calculation of discount factors. This is
achieved by multiplying the interest rate by (1 – tax rate).
The after-tax cost of the bank loan facility is:
7.8% × (1 – 30%) = 7.8% × 70%
which gives an effective after-tax rate of 5.46%.
NPV calculation
Net benefits from $795,000 ($181,000) ($181,000) ($181,000) ($181,000) ($246,000)

previous table
Discount factors at 1.000 0.948 0.899 0.853 0.808 0.767

5.46%
Present value $795,000 ($171,588) ($162,719) ($154,393) ($146,248) ($188,682)
Net present value ($28,630)

The analysis shows a negative NPV, which suggests that from a pure financing perspective,
buying the asset, rather than leasing it, is the most economical option. Accutime will need to
carefully weigh a range of qualitative factors in making a final determination.
Note: Accutime has already used capital budgeting techniques covered in Unit 12, which may
include NPV, to determine that it is appropriate to go ahead with the Sakikawa SX robot project.
The aim of this activity is to use NPV techniques to ascertain the most economical option for
financing it.

ACT
Unit 15: Long-term financial management
Activity 15.1
Financial restructuring
Introduction
This activity illustrates the impact of changes in the capital structure on key ratios of a business.
• Apply the major theories and practical tools to the evaluation of capital structure decisions.
At the end of this activity you will be able to calculate the impact of a change in capital structure
on key ratios of a business.
Scenario
You are employed as an accountant for a large construction company, and report directly to the
chief financial officer (CFO). Construction activity has been declining in recent years, reducing
earnings and pushing the share price down. The market is concerned about the amount of
maturing debt that needs to be refinanced within the next 18 months. A recent research report
by a leading broker commented that the company was too highly geared for the current stage
of the business cycle. Analysts have also made the point that lower gearing would also put
the company in a better position to take advantage of any opportunities to make value-adding
acquisitions that were likely to emerge in the near future.
The CFO has developed a plan for a more conservative capital structure that should assuage
investor concerns, provide continued access to credit markets on acceptable terms and increase
financial flexibility.
They plan to reduce Net debt / (Net debt + equity) as a %, from around 45% to a target level of
35%. The capital structure initiative includes raising $400 million in a private placement of equity
to institutional investors and $50 million under a share purchase plan. These funds would be
used to repay maturing debt of $450 million. This debt bears an interest rate of approximately
8.0%. Shares are to be sold at $8.00, a 6.1% discount to the current market price $8.52.
maaf12115_act_02

ACT
The most recent financials, in abbreviated form, are as follows:
$ million
EBITDA 653
Depreciation and amortisation 222
EBIT 431
Interest 161
Earnings before tax 270
Tax (30%) 81
Earnings after tax 189
Cash 85
Short-term bank debt 450
Private placement debt 1,142
Subordinated bonds 447
Book equity (value of shares) 2,287
Number (million)
Issued capital (number of shares) 410.6
The CFO has asked for an analysis of the impact of the proposed capital structure initiative
on key ratios. They are particularly interested in the impact of the capital structure initiative
on two ratios specified in the debt covenants:
• EBIT/Interest.
• Senior net debt/EBITDA.
The debt covenants specify that the company must maintain the EBIT/interest ratio above 1.75
and the senior net debt/EBITDA ratio below 3.0.
They have also asked for an analysis on two ratios of interest to the market:
• Net debt/(Net debt plus equity).
• EPS.
For the purposes of the analysis you should assume that additional earnings are distributed
as dividends.
Note: Senior debt includes the bank debt and private placement debt. Net debt is defined as
debt less cash and cash equivalents; therefore, the difference between them in this activity is
the subordinated bonds which would rank below bank debt and private placement debt in
a wind‑up situation.
Tasks
1. Calculate the four ratios required by the CFO under the current capital structure and
the proposed capital structure.
2. Critique the overall impact of the financial restructuring.

ACT
Solution
Task 1
Current Proposed
Net debt/(Net debt + equity) 46.1% 34.9%
Senior net debt/EBITDA 2.31 1.56
EBIT/Interest 2.68 3.45
EPS $0.460 $0.458
Task 2
The financial restructuring will almost achieve the CFO’s objective of reducing gearing to 35%,
with a minimal impact on EPS. The reduction in debt will give the company more headroom
with its senior net debt/EBITDA and EBIT/Interest ratios. The former has been reduced to nearly
one-half of the covenant maximum level while the latter has been increased to nearly the twice
the covenant minimum. The company is now better positioned to weather any deterioration
in economic conditions. The increase in financial flexibility gives the company room to take on
additional debt should an attractive acquisition become available.

ACT
The steps outline the recommended approach for successfully completing each task.
Task 1
Step 1 – Recast the extract from the financial statements to reflect the impact
of the equity raising and retirement of the bank debt
The repayment of $450 million of debt bearing an interest rate of 8.0% should reduce interest
expense by ($450 million × 0.08) $36 million.
On the balance sheet, the $450 million equity raising to repay short-term bank debt should boost
book equity by $450 million and reduce short-term bank debt by $450 million.
The $450 million equity raising will require ($450 million ÷ $8) 56.25 million new shares to
be issued.
Current Change Proposed

$ million $ million
EBITDA 653 653
Depreciation and amortisation 222 222
EBIT 431 431
Interest 161 (36) 125
Earnings before tax 270 36 306
Tax (30%) 81 11 92
Earnings after tax 189 25 214
Cash 85 25 110
Short-term bank debt 450 (450) 0
Private placement debt 1,142 1,142
Subordinated bonds 447 447
Book equity 2,287 450 2,737
Number of shares Number of shares

(million) (million)
Issued capital 410.6 56.25 466.85

ACT
Step 2 – Recalculate the ratios

The components of the ratios which require further calculation are:
Net debt = short-term bank debt + private placement debt + subordinated bonds – cash
Senior net debt = short-term bank debt + private placement debt – cash
The formula for the EPS calculation is:

Earnings after tax
EPS = _________________
   
    
Issued capital
Therefore, the ratios for both scenarios are calculated as follows:

Current Proposed
Net debt 1,954 1,468

 _____________
  
      ____________
   = 0.461 or 46.1%  ____________
   = 0.349 or 34.9%
Net debt + equity 1,954 + 2,287 1,468 + 2,737
Senior net debt

______________ 1,507
_____ 1,021
_____
          = 2.31     = 1.56
EBITDA 653 653
  EBIT  

_______   431  = 2.68
____   431  = 3.45
____
Interest 161 125
EPS   189   = 0.460

_____   214   = 0.458
______
410.6 466.85
Task 2
Analyse the change in the ratios and assess whether or not the financial restructure will
achieve its objective ‘for a more conservative capital structure that should assuage investor
concerns, provide continued access to credit markets on acceptable terms and increase
financial flexibility’.


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Chartered Accountants Program Management Accounting & Applied Finance

Unit 1: Management accounting and

Unit 1 – Activities Page 1-1

Relationships (how I relate)

Intellect (how I think)

Mindset (who I am)

Expertise (what I have)

Unit 1 – Activities Page 1-3

Unit 1 – Activities Page 1-5

Step 1 – Consider the applicability of the treasury structures

Outsourced treasury structure

Centralised treasury structure

Page 1-6 Activities – Unit 1

Decentralised treasury structure

Unit 1 – Activities Page 1-7

Unit 1 – Activities Page 1-9

Unit 1 – Activities Page 1-11

Unit 1 – Activities Page 1-13

Page 1-14 Activities – Unit 1

The number of stores are declining, reducing the

Given the success of the strategic alliance with the

Unit 1 – Activities Page 1-15

Page 1-16 Activities – Unit 1

Unit 1 – Activities Page 1-17

Page 1-18 Activities – Unit 1

Unit 1 – Activities Page 1-19

paid fishing trip, including

Page 1-22 Activities – Unit 1

Unit 2: Managing business risk

Unit 2 – Activities Page 2-1

To achieve this, Accutime must continue to develop leading industry innovations in

For compliance risk Accutime examples include:

Unit 2 – Activities Page 2-3

Risk Potential implication on operations

Room becomes contaminated • Production is disrupted while room is decontaminated

Power surge causes robotic equipment to • Production is disrupted

Robotic equipment breaks down • Production disrupted

A mistake is made by a technician in finishing, • Defective product – resources wasted

Page 2-4 Activities – Unit 2

Unit 2 – Activities Page 2-5

Financial risks at SDT

Financial risk category Explanation

Step 2 – Review the SDT case study

Step 3 – Document the applicable risks

Unit 2 – Activities Page 2-7

Unit 2 – Activities Page 2-9

Page 2-10 Activities – Unit 2

Step 2 – Use your understanding of a natural hedge to choose the appropriate

Unit 2 – Activities Page 2-11

Possible derivative tools

Derivative tools Implications for KDY

Page 2-12 Activities – Unit 2

Unit 3: Analysing operations

Unit 3 – Activities Page 3-1

Page 3-2 Activities – Unit 3

1. Relevant and differential cost model

2. Opportunity cost model