ACCA F5 Performance Management

Cheatsheet Content

1. Activity Based Costing (ABC) Definition: A costing method that identifies activities in an organization and assigns the cost of each activity with resources to all products and services according to the actual consumption by each. Cost Drivers: Activities that cause costs. Examples include: Unit-level: Direct labor hours, machine hours, units produced. Batch-level: Number of setups, production runs, purchase orders. Product-level: Product design changes, product engineering. Facility-level: General factory management, building depreciation. Steps: Identify activities. Assign costs to activity cost pools. Determine cost drivers for each pool. Calculate cost driver rates. Assign activity costs to products/services. Benefits: More accurate product costing, better decision making, improved cost management. Limitations: Complex to implement, cost driver selection can be subjective. 2. Target Costing Definition: A costing method that establishes the allowable cost of a product or service based on a target selling price (market-driven) and a desired profit margin. Target Cost = Target Selling Price - Desired Profit Margin Cost Gap: The difference between the estimated current cost and the target cost. Cost Gap = Estimated Current Cost - Target Cost Methods to Close Cost Gap: Value analysis, functional analysis, process improvement, material substitution, re-engineering, supplier negotiation. Benefits: Market-driven approach, encourages cost reduction at design stage, customer focus. Limitations: May lead to quality compromises, can be time-consuming, requires strong market research. 3. Life Cycle Costing Definition: A method that tracks and accumulates costs and revenues attributable to a product over its entire life cycle, from research and development (R&D) to abandonment. Stages of Product Life Cycle: R&D & Design: High costs, no revenue. Introduction: High costs (marketing), low sales, potential losses. Growth: Rising sales, increasing profits. Maturity: Stable sales, peak profits, competition increases. Decline: Falling sales and profits. Costs Included: R&D, design, production, marketing, distribution, customer service, decommissioning/disposal. Benefits: Provides a holistic view of profitability, encourages long-term planning, highlights the importance of early-stage cost control. Limitations: Difficult to estimate costs and revenues over a long period, especially for new products. 4. Throughput Accounting (TA) Definition: A management accounting system that focuses on maximizing throughput (revenue minus direct material costs) while minimizing operating expenses and inventory. Key Concepts (Theory of Constraints - TOC): Throughput (T): Sales revenue - Direct material cost. Inventory (I): All money tied up in the system (raw materials, WIP, finished goods). Operating Expenses (OE): All other costs incurred to convert inventory into throughput (labour, overheads). Goal: Increase T, decrease I, decrease OE. Bottleneck: The resource that limits the overall output of the system. Throughput Accounting Ratio (TPAR): Measures efficiency of bottleneck usage. TPAR = Throughput per bottleneck hour / Operating expense per bottleneck hour If TPAR > 1, the product is profitable. Steps to Manage Bottleneck (TOC): Identify the bottleneck. Exploit the bottleneck (maximize its output). Subordinate all other activities to the bottleneck. Elevate the bottleneck (increase its capacity). If the bottleneck shifts, go back to step 1. Benefits: Focuses on profit maximization, effective for short-term decision making with bottlenecks. Limitations: Assumes direct labour is fixed, may ignore longer-term strategic issues. 5. Environmental Accounting Definition: Identifies, measures, and reports environmental costs and benefits to assist management in making informed decisions. Categories of Environmental Costs (US EPA): Conventional Costs: Raw materials, energy, waste disposal. Potentially Hidden Costs: Upfront (e.g., permits), backend (e.g., decommissioning), regulatory-driven (e.g., monitoring). Contingent Costs: Fines, penalties, legal fees. Image and Relationship Costs: Public relations, community relations. Techniques: Activity-Based Costing (ABC): Identifies environmental activities and their costs (e.g., waste treatment, pollution control). Life Cycle Costing: Considers environmental costs over a product's entire life. Flow Cost Accounting: Tracks material flows and identifies environmental costs related to material losses. Input/Output Analysis: Monitors material inputs and outputs to identify waste and pollution. Benefits: Improved environmental performance, cost savings, enhanced public image, compliance with regulations. Limitations: Difficulty in quantifying some environmental costs/benefits, lack of standardized reporting. 6. Relevant Costing Definition: Costs that are relevant to a decision are future, incremental cash flows. Key Principles: Future Costs: Only costs that will be incurred in the future are relevant. Past costs (sunk costs) are irrelevant. Incremental Costs: Only costs that change as a direct result of the decision are relevant. Costs that remain the same regardless of the decision are irrelevant (committed costs, allocated fixed costs unless incremental). Cash Flows: Only cash expenditures are relevant. Non-cash items (like depreciation) are irrelevant, except indirectly if they affect cash (e.g., tax). Opportunity Costs: The benefit forgone by choosing one alternative over another. These are always relevant if a resource is scarce. Treatment of Specific Items: Materials: In regular use: Current replacement cost. Not in regular use, no alternative use: Scrap value (if any). Not in regular use, alternative use: Opportunity cost of alternative use. Labour: Spare capacity: Zero relevant cost (unless overtime is paid). Full capacity: Cost of labour + opportunity cost (contribution forgone from alternative work). Fixed Overheads: Generally irrelevant unless directly incremental to the decision (e.g., hiring a new supervisor for a specific project). Benefits: Leads to optimal decision-making by focusing on what truly matters. Limitations: Can be complex to apply, ignores qualitative factors. 7. Cost-Volume-Profit (CVP) Analysis Definition: A technique that examines the relationship between costs, sales volume, and profit. Key Concepts: Contribution Margin (CM): Selling Price per Unit - Variable Cost per Unit. Contribution Margin Ratio (CM Ratio): CM per Unit / Selling Price per Unit. Break-Even Point (BEP): The level of activity where total revenues equal total costs (zero profit). BEP (Units) = Fixed Costs / CM per Unit BEP (Sales Revenue) = Fixed Costs / CM Ratio Target Profit: Units for Target Profit = (Fixed Costs + Target Profit) / CM per Unit Sales Revenue for Target Profit = (Fixed Costs + Target Profit) / CM Ratio Margin of Safety (MOS): The excess of actual or budgeted sales over break-even sales. MOS (Units) = Budgeted Sales (Units) - BEP (Units) MOS (%) = (Budgeted Sales - BEP Sales) / Budgeted Sales × 100% Assumptions: Costs can be accurately separated into fixed and variable. Linear relationships for costs and revenues. Sales mix remains constant (for multi-product analysis). Production equals sales (no inventory changes). Efficiency is constant. Benefits: Useful for planning, pricing decisions, and assessing risk. Limitations: Simplistic assumptions, may not hold in real-world scenarios. 8. Limiting Factor Analysis (Linear Programming) Definition: A technique used to optimize production when there are one or more scarce resources (limiting factors). Steps (Single Limiting Factor): Identify the limiting factor. Calculate contribution per unit for each product. Calculate contribution per unit of limiting factor. Rank products based on contribution per unit of limiting factor. Allocate resources according to rank until the limiting factor is exhausted. Linear Programming (Multiple Limiting Factors): Objective Function: Expresses the goal (e.g., maximize contribution) in terms of decision variables (e.g., number of units of each product). Constraints: Expresses resource limitations as inequalities (e.g., material available, labour hours). Graphical Method: Plot constraints, identify feasible region, find optimal solution at a corner point. Shadow Price (Dual Price): The increase in the objective function (e.g., contribution) if one additional unit of a scarce resource is made available. Slack: The amount of a resource that is not fully utilized. Benefits: Optimal resource allocation, maximizes profit in constrained environments. Limitations: Assumes linear relationships, problems with many variables are complex, qualitative factors ignored. 9. Pricing Decisions Pricing Strategies: Cost-Plus Pricing: Adding a mark-up to cost (e.g., marginal cost plus, full cost plus). Benefits: Simple, ensures costs are covered. Limitations: Ignores demand, market conditions, competition. Market Skimming: Setting a high initial price for a new product to "skim" maximum revenue from early adopters. Conditions: High R&D, inelastic demand, strong brand, barriers to entry, short product life cycle. Penetration Pricing: Setting a low initial price to attract a large number of buyers quickly and gain market share. Conditions: Elastic demand, economies of scale, discourage competitors, long product life cycle. Price Discrimination: Charging different prices for the same product/service to different customer segments. Conditions: Market segmentation possible, different price elasticities, prevention of resale, legality. Product-Line Pricing: Setting prices for a range of related products. Competitive Pricing: Setting prices based on competitors' prices. Perceived Value Pricing: Based on the perceived value to the customer, rather than cost. Price Elasticity of Demand (PED): Measures the responsiveness of demand to a change in price. PED = % Change in Quantity Demanded / % Change in Price If |PED| > 1: Elastic demand (price increase reduces total revenue). If |PED| If |PED| = 1: Unitary elastic demand (price change has no effect on total revenue). Demand Function (Linear): $P = a - bQ$ $b = \frac{\text{Change in Price}}{\text{Change in Quantity}}$ $a = \text{Price when } Q=0$ Marginal Revenue (MR): $MR = a - 2bQ$ Profit Maximization: $MR = MC$ (Marginal Cost) 10. Make or Buy Decisions Definition: Deciding whether to produce a component or service internally ("make") or purchase it from an external supplier ("buy"). Relevant Costs: Focus on incremental costs and opportunity costs. Costs Avoided by Buying: Variable manufacturing costs, specific fixed costs that can be eliminated. Opportunity Costs of Making: Contribution forgone from alternative uses of released capacity. Costs Incurred by Buying: Purchase price, transportation, inspection. Qualitative Factors: Supplier reliability, quality control, confidentiality, future capacity, impact on employees, strategic importance. 11. Dealing with Risk and Uncertainty Risk vs. Uncertainty: Risk: Probabilities of outcomes are known or can be estimated. Uncertainty: Probabilities of outcomes are unknown. Decision Rules (under Uncertainty): Maximax: Choose the option with the best possible outcome (optimistic, risk-seeker). Maximin: Choose the option with the best worst outcome (pessimistic, risk-averse). Minimax Regret: Minimize the maximum regret (opportunity loss) for each decision (risk-averse). Expected Value (EV): Weighted average of possible outcomes, where weights are probabilities. $EV = \sum (Outcome_i \times Probability_i)$ Useful for repeatable decisions, assumes risk-neutrality. Value of Perfect Information (VOPI): The difference between the expected value with perfect information and the expected value without it. Sensitivity Analysis: Examines how sensitive the decision is to changes in key variables (e.g., sales volume, costs). Decision Trees: Graphical representation of decision points, chance events, and outcomes. Used to calculate EVs for sequential decisions. 12. Budgetary Systems Purpose of Budgeting: Planning, coordination, communication, motivation, control, performance evaluation. Types of Budgets: Incremental Budgeting: Based on previous period's budget, with adjustments for inflation/activity changes. Pros: Simple, quick. Cons: Perpetuates inefficiencies, encourages slack. Zero-Based Budgeting (ZBB): Starts from scratch, requiring justification for all expenditures. Pros: Efficient resource allocation, identifies waste. Cons: Time-consuming, complex, difficult for qualitative activities. Activity-Based Budgeting (ABB): Budgeting based on activities and their cost drivers. Pros: More accurate, links activities to strategy. Cons: Complex, costly. Flexible Budgeting: Adjusts for changes in activity levels, separating fixed and variable costs. Pros: Better for performance evaluation, provides appropriate benchmarks. Cons: Requires cost behavior analysis. Rolling Budgets: Continuously updated by adding a new period as the current one expires. Pros: Always up-to-date, adaptable. Cons: Time-consuming, can be demotivating if targets change. Beyond Budgeting: Focuses on adaptive management and continuous improvement, moving away from traditional fixed annual budgets. Behavioral Aspects: Participation: Top-down (imposed) vs. Bottom-up (participative). Participative: Motivates, more accurate. Cons: Budgetary slack, time-consuming. Budgetary Slack: Deliberately understating revenues or overstating costs to make targets easier to achieve. 13. Quantitative Analysis in Budgeting High-Low Method: Used to separate fixed and variable costs from mixed costs. Variable Cost per Unit = (Cost at High Activity - Cost at Low Activity) / (High Activity - Low Activity) Fixed Costs = Total Cost at High Activity - (Variable Cost per Unit × High Activity) Learning Curve: As cumulative production doubles, the cumulative average time per unit decreases by a constant percentage. Formula: $Y_x = ax^b$ $Y_x$: Cumulative average time for $x$ units. $a$: Time for the first unit. $x$: Cumulative number of units. $b$: Learning index ($\frac{\log \text{Learning Rate}}{\log 2}$). Applies to: New products, complex tasks, manual operations, stable workforce. Stops when: Production becomes routine, machine-paced, or design changes. Probabilistic Budgeting: Incorporates probability distributions for uncertain variables to generate a range of possible outcomes. Spreadsheets: Benefits: Quick calculations, sensitivity analysis, what-if scenarios. Limitations: Errors in formulae, data security, qualitative factors ignored. 14. Standard Costing and Variance Analysis Standard Costs: Predetermined costs for materials, labour, and overheads. Ideal: Perfect efficiency, no waste. (Demotivating) Attainable: Efficient but allows for normal losses/downtime. (Motivational) Basic: Unchanged over long periods. (Outdated) Current: Reflects current conditions. (Useful for control) Variances (Basic): Material Price Variance (MPV): (Actual Price - Standard Price) × Actual Quantity Purchased. Material Usage Variance (MUV): (Actual Quantity Used - Standard Quantity for Actual Production) × Standard Price. Labour Rate Variance (LRV): (Actual Rate - Standard Rate) × Actual Hours Paid. Labour Efficiency Variance (LEV): (Actual Hours Worked - Standard Hours for Actual Production) × Standard Rate. Labour Idle Time Variance: (Idle Hours) × Standard Rate. Mix and Yield Variances (Materials and Sales): Used when output is a result of mixing different inputs or selling different products. Mix Variance: Measures the impact of using a different proportion of inputs/products than standard. Yield Variance: Measures the impact of achieving more or less output than expected from the total input. Planning and Operational Variances: Separates variances into those arising from faulty planning (planning variance) and those from inefficient execution (operational variance). Planning Variance: (Original Standard - Revised Standard) × Actual Quantity (or volume). Operational Variance: (Revised Standard - Actual) × Actual Quantity (or volume). Benefits: Fairer performance appraisal, identifies out-of-date standards. Limitations: Subjectivity in setting revised standards, can lead to blame culture. 15. Performance Measurement and Control Management Information Systems (MIS): Provides information for planning, control, and decision-making. Transaction Processing Systems (TPS): Handles day-to-day routine transactions. Management Information Systems (MIS): Summarizes internal data into periodic reports. Decision Support Systems (DSS): Interactive systems for decision-making, often involving models and "what-if" analysis. Executive Information Systems (EIS): Provides summarized, critical strategic information for top management (dashboards). Enterprise Resource Planning Systems (ERPS): Integrated systems covering all functional areas of an organization. Performance Analysis in Private Sector: Financial Measures: Profitability (ROI, RI), liquidity, gearing. Non-Financial Measures: Customer satisfaction, quality, employee turnover, market share, innovation. Balanced Scorecard: Measures performance across four perspectives: Financial: How do we look to shareholders? Customer: How do customers see us? Internal Business Process: What must we excel at? Learning & Growth: Can we continue to improve and create value? Fitzgerald and Moon's Building Blocks: Framework for service organizations: Dimensions: Competitiveness, financial performance, quality, flexibility, resource utilization, innovation. Standards: Targets for performance (fair, achievable, controllable). Rewards: Incentives for achieving standards (clear, motivating, controllable). Short-termism: Focus on immediate results at the expense of long-term sustainability. Divisional Performance & Transfer Pricing: Responsibility Centres: Cost Centre: Manager controls costs only. Revenue Centre: Manager controls revenues only. Profit Centre: Manager controls costs and revenues. Investment Centre: Manager controls costs, revenues, and investments. Return on Investment (ROI): Profit / Capital Employed. Pros: Simple, widely understood. Cons: Encourages short-termism, goal incongruence (rejecting profitable projects). Residual Income (RI): Profit - (Capital Employed × Cost of Capital). Pros: Promotes goal congruence, uses absolute measure. Cons: Does not facilitate comparison of divisions of different sizes. Transfer Pricing: Price charged for goods/services transferred between divisions of the same company. Goal: Promote goal congruence, preserve divisional autonomy, provide accurate performance measures. Methods: Market price, cost-plus (variable/full), negotiated price, dual pricing. General Rule: Minimum TP $\ge$ Marginal cost + Opportunity cost. Maximum TP $\le$ External buy-in price (or Net Marginal Revenue for buying division). Performance Analysis in Not-for-Profit/Public Sector: Objectives: Service delivery, social welfare (not profit). Value for Money (VFM): Economy: Minimizing cost of inputs (e.g., purchasing at lowest price). Efficiency: Relationship between inputs and outputs (e.g., output per staff hour). Effectiveness: Achieving desired outcomes (e.g., customer satisfaction, meeting service goals). Challenges: Multiple, often conflicting objectives; difficulty in quantifying outputs/outcomes; political influence; multiple stakeholders.