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F5 - Management accounting
F5 Performance Management
Presentation Objective
To provide a revision tool to students writing paper F5 To provide exam focus study that saves time
F5 Performance Management
Outline F2 revision Modern management accounting Cost volume profit (CVP) analysis The Concept of limiting factor analysis Pricing decisions Short-term decisions Risk and uncertainty Budget and budgetary control Quantitative analysis in budgeting Standard costing and variance analysis Performance measurement
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F5 Performance Management
F5 Performance Management
F2 Management Accounting gave the background to paper f5. It is better youre confident with the concepts and techniques learnt at the lower level.
Costing is the process of determining the cost of products, services or activities. Methods include absorption costing and process costing. Direct cost = D.M + D.L + D. EXP All direct production costs are referred to as PRIME COSTS. Addition of all indirect costs = Overheads. Direct + indirect = Total factor cost. Absorption costing is a method of sharing out overheads incurred amongst units produced. It follows three processes: Allocation Apportionment Absorption: may lead to under/over absorbed overhead
F5 Performance Management
F2 revision
For absorption
When sales fluctuate because of seasonality in sales demand but production is held constant, absorption costing avoids large fluctuations in profit. Prices based on marginal cost (minimum prices) does not guarantee profit. Absorption recognises that all costs are variable in the long run. It is the method allowed by accounting standards.
It shows how an organisation's cash flows and profits are affected by changes in sales volumes since contribution varies in direct proportion to units sold. By using absorption costing and setting a production level greater than sales demand, profits can be manipulated. Total costs need separation for decision making For short-run decisions in which fixed costs do not change, fixed costs are irrelevant.
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F5 Performance Management
Activity based costing (ABC) Target costing Life cycle costing Throughput accounting Environmental accounting
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F5 Performance Management
Steps to follow in ABC 1Identify major activities. 2 Identify cost drivers (factors which determine the size of an activity/cause the costs of an activity). 3 Collect costs associated with each activity into cost pools. 4 Charge costs to products on the basis of the Why ACT is not enough One basis of absorption volume number of an activitys cost driver they generate. Companies now produce variety of Products Cost drivers May hide inefficiency. Volume related (eg labour hrs) for costs that vary with production volume in the short term (eg power Allocate more ohds to volume-based product costs) Transactions in support departments for other costs (eg No of visit for site supervisor costs)
Target costing
F5 Performance Management
Involves setting a target cost by subtracting a desired profit margin from a competitive market price The target cost may be less that the initial product cost but it is expected to be achieved by the time the product reaches maturity There is a focus on price-led costing, customer requirements and design Steps in target costiing 1. Do market research to obtain a competitive price 2. Determine the required magin 3. Cal. target cost = estimated SP reqd margin 4. Compare the estimated costs with the target 5. Cost gap exists if estimated > target.
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F5 Performance Management
This method tracks and accumulates costs and revenues over a products entire life. This cycle include 1. Development 2. Introduction 3. Growth 4.Maturity 5. Decline
1. 2. 3. 4. 5. 6.
Design costs out of products Minimise the time to market Minimise breakeven time Maximise the length of the life span Minimise product proliferation Manage the products cashflows
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F5 Performance Management
Sales Volume
Sales
Profit
Time Introduction Growth Maturity Decline
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Throughput accounting
Basic concept of throughput
F5 Performance Management
In the short run, all costs except materials are fixed In a JIT environment, the ideal inventory level is zero. So unavoidable, idle capacity in some operations must be accepted The factory spends money when goods are produced and a product makes money when it sold. Overall profitability is determined by how fast the product makes money compare to how the factory spends.
Throughput accounting ratio = Return per factory hour Total conversion cost per factory hour TPAR > 1 = Continue Product TPAR < 1 = Cease Product Before cessation, consider other qualitative factors. Or consider working on the product for TPAR to > 1.
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F5 Performance Management
Definition
The generation and analysis of both financial and non-financial information in order to support environmental management processes.
Importance
Identifying environmental costs associated with individual products and services can assist with pricing decisions Ensuring compliance with regulatory standards Potential for cost savings
Consumables and raw materials Transport and travel Waste and effluent disposal Water consumption Energy
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F5 Performance Management
How to calculate a multi-product C/S (or profit volume or P/V) ratio Calculation of breakeven sales: 1. Calculate the revenue per mix. 2. Calculate the contribution per mix. 3. Calculate the average C/S ratio. 4. Calculate the total breakeven point. 5. Calculate the revenue ratio per mix. 6. Calculate the breakeven sales.
It is vital to remember that for multi-product Breakeven analysis, a constant product sales mix must be assumed.
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Cost volume profit (CVP analysis) Target profits 1. Calculate the contribution per mix. 2. Calculate the required number of mixes. 3. Calculate the required number of units and 4. sales revenue of each product. Limitations of CVP analysis
F5 Performance Management
It is assumed that fixed costs are the same in total and variable costs are the same per unit at all levels of output It is assumed that sales prices will be constant at all levels of activity Production and sales are assumed to be the same Uncertainty in estimates of fixed costs and unit variable costs is often ignored
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Decision making time Decision making is an important aspect of the Paper F5 syllabus, and questions on this topic will be common.but this article will focus on only one: linear programming.
F5 Performance Management
.The first step in any linear programming problem is to produce the equations for constraints and the contribution function. This should not be difficult at this level.
Excerpts from technical article by Geoff Cordwell former examiner for Paper F5.
Linear programming
Formulating the problem
F5 Performance Management
Steps in linear programming 1. Define variable 2. Construct objective function 3. Establish constraints 4. Graph 5. Find the optimal solution There are two methods of finding the optimal solution: 1. Graphical method 2. Using equations
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Linear Programming
Slack
Occurs when maximum availability of a resource is not used. The resource is not binding at the optimal solution. Slack is associated with constraints.
F5 Performance Management
Surplus
Occurs when more than a minimum requirement is used. Surplus is associated with constraints eg a minimum production requirement
Shadow price It is the increase in contribution created by the availability of an extra unit of a limited resource at its original cost. It is the maximum premium an organisation should be willing to pay for an extra unit of a resource. It provides a measure of the sensitivity of the result. It is only valid for a small range before the constraint becomes non-binding or different resources become critical.
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Pricing decisions
Influence on price 1. Cost 2. Demand 3. Income level 4. Competition 5. Quality perception 6. Market structure 7. Product life cycle 8. E.c.t.
F5 Performance Management
A measure of the extent of change in market demand for a good, in response to a change in its price = change in quantity demanded, as a % of demand change in price, as a % of price
Inelastic demand <1 Demand falls by a smaller % than % rise in price Pricing decision: increase prices Elastic demand >1 Demand falls by a larger % than % rise in price Pricing decision: decide whether change in cost will be less than change in revenue. NB: For pricing strategy to be adopted, make reference to PED.
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Profit Maximisation
Determining the profit-maximising selling price/output level
F5 Performance Management
Pricing strategy
Full cost plus Advantages Quick, simple, cheap method Ensures company covers fixed costs. Disadvantages Doesnt recognise profit maximising price and output Budgeted output needs to be established Suitable basis for overhead absorption needed
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F5 Performance Management
Make or Buy Compare internal differential production costs with suppliers quotation. Consider other qualitative factors before sub-contracting or outsourcing
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F5 Performance Management
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F5 Performance Management
The technique that a decision maker will use in dealing with risk and uncertainty will be dependent on his risk attitude. Attitude to risk Risk seeker A decision maker interested in the best outcomes no matter how small the chance that they may occur Risk neutral A decision maker concerned with what will be the most likely outcome Risk averse A decision maker who acts on the assumption that the worst outcome might occur
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F5 Performance Management
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F5 Performance Management
Budgetary systems
F5 Performance Management
Zero-based budgeting
F5 Performance Management
Zero-based budgeting
This approach treats the preparation of the budget for each period as an independent planning exercise: the initial budget is zero and every item of expenditure has to be justified in its entirety to be included. It is usually developed as a package. Steps in ZBB 1. Define decision packages 2. Evaluate and rank packages on the basis of their benefit to the organisation. 3. Allocate resources according to the funds available and the ranking of packages.
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Merit
Identifies and removes inefficient and/or obsolete operations Provides a psychological impetus to employees to avoid wasteful expenditure Leads to a more efficient allocation of resources
Standard costing
Uses of standard costing
To act as a control device (variance analysis) To value inventories and cost production To assist in setting budgets and evaluating managerial performance To enable the principle of management by exception to be practiced To provide a prediction of future costs for use in decision-making situations To motivate staff and management by providing challenging targets To provide guidance on possible ways of improving efficiency
F5 Performance Management
Types of standard
Ideal Perfect operating conditions Unfavourable motivational impact Attainable Allowances made for inefficiencies and wastage Incentive to work harder (realistic but challenging) Current Based on current working conditions No motivational impact Basic Unaltered over a long period of time Unfavourable impact on performance
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Variance analysis
A standard cost card will look as follows:
F5 Performance Management
$/unit Direct material (20kg@$5/kg) Direct labour Prime costs Variable Overheads(10hrs@$10/hr) Total variable cost Fixed cost (10hrs@$12/hr) Total factory cost Profit (25% mark-up) Selling price (10hrs@$5/hr) 100 50 150 100 250 120 370 92.50 462.50
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F5 Performance Management
(F) unforeseen discounts received (A) price increase, careless purchasing (F) material used higher quality than standard (A) defective material, waste, theft (F) use of less skilled (lower paid) workers (A) rate increase (always (A)) machine breakdown, illness (F) better quality materials (A) lack of training
Labour efficiency
Overhead expenditure (F) cost savings (A) excessive use of services Overhead volume - production greater or less than budgeted
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F5 Performance Management
Operational variances
Caused by adverse/favourable operational performance Calculated by comparing actual results with a realistic, revised standard/budget
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Performance measurement Financial performance indicators (FPI) Profitability ratio ROCE Profit margin Sales growth Asset turnover Liquidity ratios Inventory days Receivable days etc
F5 Performance Management
Non-financial performance indicators (NFPI) Look at a wider range of variables Provide information on quality and customer satisfaction Better indicator of future prospects Can be provided quickly and tailored to circumstances
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Balanced Scorecard
Perspective Question
F5 Performance Management
Explanation
Customer
Gives rise to targets that matter to customers: cost, quality, delivery, inspection, handling and so on.
Internal
What processes must we excel at to achieve our financial and customer objectives?
Considers the business's capacity to maintain its competitive position through the acquisition of new skills and the development of new products. Covers traditional measures such as growth, profitability and shareholder value but set through talking to the shareholder or shareholders direct.
Financial
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F5 Performance Management
Suggested way out Multiple objectives Measuring outputs Lack of profit measure Nature of service provided Financial constraints Political, social and legal considerations
Judge performance in terms of inputs Use experts subjective judgment Use benchmarking Use unit cost quantitative measures
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F5 Performance Management
Efficiency: Relationship between inputs and outputs (getting out as much as possible for what goes in) Effectiveness: Relationship between outputs and objectives (getting done what was supposed to be done) Economy: Obtaining the right quality and quantity of inputs at lowest cost (being frugal)
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F5 Performance Management