F2- Management

accounting
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 BPP text and revision kit
 Lecture note
 Slides and exercise sheets
 ACCA student website

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Syllabus

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Part E Performance measurement

I. Performance measurement and Planning and

control
II. Measuring performance
III. Application of performance measurement
IV. Cost management

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Part E- 1- Performance measurement and
planning and control

1. Link from mission to target

2. Performance measures

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 1. Link from mission to target

Mission statement

Strategic objectives

Critical success factors (CSFs)

Key performance indicators-> Measures to assess performance

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1. Link from mission to target
1.1. Mission
 The mission statement defines what the organization

should be doing in the longer term and how it should go

about doing it.
>>>>> impacts on the implementation of the plans

Purpose

Value and 4 elements

Strategy
culture

Policies and standard

of behavior

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1. Link from mission to target
1.1. Mission
 Characteristics of a mission statement:

◦ - Brevity
◦ - Flexibility
◦ - Distinctiveness

 Mission and planning relationships:

◦ - Plans should outline the fulfillment of the mission
◦ - Mission acts as a yardstick to evaluation and
screening the plans
◦ - Mission impacts on the implementation of the plans

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1. Link from mission to target

1.2. Goals and objectives

 Goals are derived from vision and mission

 Goals = Operational goals + Non-operational goals

 Operational goals can be expressed as objectives

 Objectives are quantified statements of what the

organization actually intends to achieve over a period of

time => Be SMART
 Specific

 Measurable

 Attainable

 Realistic

 Timely

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1. Link from mission to target
1.2. Goals and objectives
 Objectives can be:
◦ Long term and short term
◦ Strategic, tactical and operational
◦ Corporate and unit objectives
◦ Primary and secondary
 Manager’s performance is measured on short-term results
lead to the short-termism => Short-termism is when there is
a bias towards short-term rather than long-term
performance.
 Organizations often make trade-off between short-term and
long-term objectives => Need to take steps to encourage
managers to take a long-term view.

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1. Link from mission to target
1.3. Critical success factors (CSF)
 A CSF is a performance requirement that is

fundamental to competitive/strategic success

 CSF can be set and used by:

◦ Identifying objectives and goals

◦ Determining which factors are critical for
accomplishing each objective
◦ Determining key performance indicators for
each factor- KPI. KPIs are key part of the
control system to review a strategy

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2. Performance measures
2.1. Financial and non-financial performance measures
 Financial performance measures: profit, revenue, costs,
share price, cash flow etc
 Non- financial performance measures: Quality rating,
number of customer complaints, number of warranty
claims, lead time, delivery time, etc
 Changes in cost structures (cost can be planned), the
competitive environment (full picture) and the
manufacturing environment (strategic goals) have led to
an increased use of NFIs
 Use ratios and percentages to measure performance:
o Ratios: easier to look at changes over time
o Percentages: give meaning to absolute numbers

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2. Performance measures
2.3. Economy, efficiency and effectiveness
 Economy - minimizing the cost of resources ('doing things at a

low price')
 Efficiency - performing tasks with reasonable effort ('doing

things the right way')

 Effectiveness - the extent to which objectives are met ('doing the

right things').
 3Es can be studied and measures with reference to Inputs

(Economy), Process (Efficiency) and Outputs (Effectiveness)

 Example of indicator:

◦ Financial indicators to measure efficiency: cost per unit of

activity, variance analysis
◦ Non-financial indicators to measure effectiveness: quality of
service/output, speed of response
◦ Qualitative indicators to measure effectiveness: workplace
morale, staff attitude to dealing with the public

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2. Performance measures

2. 4. PM for Non-profit making organization

 Major problems:
◦ Difficult to define the objectives
◦ Measuring outputs
◦ Lack of profit measure
◦ Define a cost unit
◦ Financial constraints
◦ Political, social and legal considerations
 Performance is usually measured by “values for money”:
◦ Economy: spending money frugally >>> controlling expenditure
◦ Efficiency: getting out as much as possible for what goes in >>>
relationship between inputs and outputs
◦ Effectiveness: getting done what was supposed to be done >>> the
relationship between an organization’s outputs and its objectives

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Part E-2- Measuring Performance

1. Measuring profitability and productivity

2. Performance measurement based on the
statement of financial position
3. Limitations of statement of PL and statement of
FP measures
4. The balanced scorecard

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Part E-2- Measuring Performance

1.1. Profitability

Responsibility Manager responsible Financial performance

center for measures

Cost center Costs Variances

Revenue center Revenue only Revenue
Profit center Costs and revenues Controllable profit
Investment center Costs, revenues and ROI= controllable profit/
assets controllable investment*100%

Residual income (RI) =

controllable profit – input interest
charged on controllable
investment

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 1. Measuring profitability and productivity
1.1. Profitability
 Return on investment (Return on capital employed):

ROI/ROCE = Profit/Capital employed

Profit = Profit/Earning before tax and interest (PBIT/EBIT)
Capital employed = Assets – Current Liabilities
or ROCE = Operating profit/(Ordinary shareholders’ funds +
non-current liabilities)
=> Profit from a normal course of business operation, not include earning
from investments and the effects of interest and taxes
 
 Residual income (RI) = Controllable profit – imputed

interest charge on controllable investment

 Advantages and Disadvantages: text book

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 1. Measuring profitability and productivity
1.1. Profitability

 Profit margin: (profit to sales ratio) = PBIT/Revenue x 100%

 Gross profit margin = Gross profit/Turnover x 100%

◦ Gross profit = Sales – cost of goods sold

 Cost to sales ratios:

◦ Production cost of sales/Sales
◦ Distribution and marketing costs/Sales
◦ Administrative costs/Sales

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 1. Measuring profitability and productivity
1.2. Productivity
 Productivity measures the quantity of the product or serviced

produced (output) in relation to the resources put in (input)

Þ Measure how efficiently resources are being used.

Ex: cost of idle time, number of invoices per employee per day,
staff cost per invoice…

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 2. Performance measurements based on the
statement of financial position
 Asset turnover = Sales/Capital employed
Profit margin x Asset turnover = ROI

 Liquidity ratios:
◦ Current ratio = Current assets/Current liabilities
◦ Quick ratio (or Acid test ratio) = (Current assets – Inventory)/
Current liabilities

 Efficiency ratios:
◦ AR collection period = AR/Average credit sales*365
◦ AP payment period = AP/Average credit purchases*365
◦ Inventory turnover period = Inventory/COGS*365
◦ Working capital cycle = AR period + Inventory period – AP
period

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 2. Performance measurements based on the
statement of financial position

 Debt ratio = total liabilities/ total assets

Prior charge capital
 Gearing (or Leverage) ratio =
Prior charge capital +
Shareholders’ equity

Note: Prior charge capital = long-term debt

 Interest cover ratio = PBIT/Interest Expense for the year

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3. Limitation of statement of PL and
statement of FP measures
 Yardsticks are needed for comparison purposes
 Difficult to compare between companies
 Historical costs are used
 Not take into account of inflation
 Must be careful in determining the measures
 External conditions can affect performance of a
business:
◦ Market conditions
◦ General economic conditions
◦ Government influences: taxation, legislation,
economic policy, encouraging policy

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4. The balance scorecard
 The balance score card measures performance in 4 different
perspectives.
◦ Customer satisfaction
◦ Process efficiency
◦ Growth
◦ Financial success
 Each perspective needs to have key performance indicators: specific,
measurable and distinctive, relevant.

Financial Customers
success

Process Growth/
efficiency Innovation

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Part E- 3- Application of performance
measurement

1. PM for manufacturing businesses

2. PM for contract and process costing
environment
3. PM for services
4. Management performance measures
5. Bench marking

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Part E- 3- Application of performance
measurement

1. PM for manufacturing businesses

Categories Measurement

Sales - Price, volume variances, revenue

targets, target market shares
- Customer rejects or
returns/total sales
- Delivery late/delivery on
schedule
- Flexibility measures: how
quickly and efficiency new
products are launched
- Number of people served and
speed of service 24
Part E- 3- Application of performance
measurement

1. PM for manufacturing businesses

Categories Measurement

Materials - standard costs/price/usage

variances
-timing and reliability of
deliveries of materials, number of
rejects in materials supplied etc

Labors -standard performance, rate and

efficiency variances
-ability to communicate,
interpersonal relationships,
customers’ impressions, levels of 25
Part E- 3- Application of performance
measurement

1. PM for manufacturing businesses

Categories Measurement

Overheads -standards and efficiency

variances
-machine down time/total
machine hours
- value added time/production
cycle time
Standard hour - Machine down time/total
machine hours
- Value added time/production
cycle time
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Part E- 3- Application of performance
measurement

2. PM for contract and process costing environment

 According to Malcolm Smith, there are 4 group of non-

financial performances:
◦ Cost: Cost behavior
◦ Quality: Factors inhibiting performance
◦ Time: Bottleneck, inertia
◦ Innovation: New product flexibility

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Part E- 3- Application of performance
measurement

3. PM for Services
6 dimensions of PM for service businesses
 Competitive performance: sales growth, market share

 Financial performance: budgeted expenditure limit, standard

performance measures
 Quality of service: measured by qualitative measures of

quality factors (access, comfort etc)

 Flexibility: speed of delivery, ability to respond to customers’

satisfactions, coping with demand

 Resource utilization: by productivity

 Innovation: E.g.: amount of spending on research and

development, the proportion of new services to total services

etc

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Part E- 3- Application of performance
measurement

4. Management performance measures

 Subjective measures: ranking performance from 1

to 5
 Judgment of outsiders: bonus in case share price

going up
 Upward appraisal: staff giving the opinions on their

managers‘ performance
 Accounting measures: cost saving target achieved

or not

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Part E- 3- Application of performance
measurement
5. Bench marking
 Bench marking is attempt to identify best practices and by

comparison of operations to achieve improved performance

 4 types of benchmarking:
◦ Internal benchmarking
◦ Functional benchmarking
◦ Competitive benchmarking
◦ Strategic benchmarking

 Usefulness of benchmarking:
◦ Setting standard
◦ Identify the process to improve
◦ Focus on planning
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Part E- 4- Cost management

1. Cost control and cost reduction

2. Cost reduction programs
3. Methods of cost reduction
4. Value analysis

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Part E- 4- Cost management
1. Cost control and cost reduction

Cost control Cost reduction

Concerned with regulating the A planned and positive approach

costs of operating a business to reducing expenditure
and keeping cost within
acceptable limits
Limit = standard cost OR target Assume: current cost levels
cost set out in formal operational and/or planned cost levels are
plan or budget too high
Actual cost is too different with
planned cost >>> Cost control
action
Aim to reduce costs to budget or Aim to reduce expected cost
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standard levels levels to below current budgeted
Part E- 4- Cost management
2. Cost reduction programs
 2 approaches:
◦ Crash programmes to cut spending levels: immediate
programme to reduce spending (problem with profitability
or cash flow)
◦ Planned programmes to reduce costs: require continual
assessments of the organization’s products, production
methods, services, internal administration system etc
 Difficulties: resistance from employees, limited to a small
area of business, etc, often introduced as a
rushed/desperate measure
 The scope of cost reduction campaigns:
◦ The activities of the entire organization
◦ Long-term aims (variable costs) and short-term aims
(fixed costs and variable costs)

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Part E- 4- Cost management
3. Methods of cost reduction
• Improving efficiency:
• Efficiency of material usage: reducing levels of wastage
• The productivity of labor: :giving pay incentives for better
productivity, improving work methods/process,
introducing and applying standards
• The efficiency of machinery or other equipment: making
better use of equipment resources, preventive
maintenance
• Material costs
• Reduce the cost of wastage
• Obtain lower prices for purchases
• Improve stores control and cut stores costs
• Cheaper substitute materials

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 Part E- 4- Cost management
3. Methods of cost reduction
• Labor costs:
• Improving efficiency or productivity
• Replacing people with machinery
• Changing the methods of work: by setting up a Work study or
O&M program to look for cost savings
 Work study: raising the productivity of an operating unit by
the reorganization of work. 2 mains parts:
o Method study: systematic recording and critical examination
of existing and proposed ways of doing work to develop
and apply easier and more effective methods and reduce
costs
o Work measurement: establishing the time for a qualified
worker to carry out a specified job at a specified level of
performance
 Organization and methods (O&M): include method study and
work measurement that are used to examine clerical,
administrative and management procedures to make
improvements (organization, staffing, office layout etc)
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Part E- 4- Cost management
3. Methods of cost reduction

• Finance costs: E.g.: taking credit from suppliers

(opportunity costs), credit terms offers to
customers, borrowing at the lowest obtainable
rates etc
• Expense items (rather than materials and labors):
E.g.: Capital expenditure proposals should be
carefully evaluated
• Control over spending decisions: e.g.: authority
for different types of spending

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Part E- 4- Cost management
4. Value analysis- an approach to cost reduction
 Value analysis is a planned, scientific approach to cost reduction,
which reviews the material composition of a product and the
product’s design so that modifications and improvements can be
made which do not reduce the product’s value to the
customer/user.
 Value engineering: the application of similar techniques to new
products so that new products are designed and developed to a
given value at minimum cost
 4 aspects of value:
◦ Cost value: Cost of producing and selling an item >>>> To
reduce
◦ Exchange value: market value of the product or service >>> To
keep it competitive
◦ Use value: the purposes it fulfils (its performance and reliability)
>>>To provide the same or better use value at the lowest cost
◦ Esteem value: the prestige the customer attaches to the product
>>> To maintain or enhance the esteem value of a product at
the lowest cost
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Part E- 4- Cost management
4. Value analysis- an approach to cost reduction
 The scope of Value analysis: 3 areas of special importance:
◦ Product design: >>> At design stage, value analysis is called
value engineering
◦ Components and material costs: >>> The role of purchasing
department at obtaining the desired quality materials at the
lowest possible price.
◦ Production methods: should be reviewed continually on a
product by product basis
 Cost reduction vs. Value analysis:
◦ Cost reduction: achieve the lowest production cost for a specific
product design >>> limit by the existing product design
◦ Value analysis: recognize that the real goal should be the least
cost method of making a product that achieves its desired
function (not a mandatory and detailed specification of product
design)

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Part E- 4- Cost management
4. Value analysis- an approach to cost reduction
 Steps in a value analysis:
◦ Select a product or service for investigation: product of high
proportion of the organization’s cost
◦ Obtain and record information about it: its aims, costs, ways of
making it etc
◦ Evaluate the product: lower cost is possible?, all features
necessary? etc
◦ Consider alternatives: Application of new technologies?,
Eliminating unnecessary parts? Introducing new methods of
operation or new sources of suppliers?
◦ Select the least-cost alternative
◦ Make a recommendation
◦ If accepted, implement the recommendation
◦ After a period, evaluate the outcome and measure the cost
savings

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Excercise
Pls. refer to appendix

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