ACCA Paper F5

Performance Management
Class Notes December 2011

 The Accountancy College Ltd, June 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of The Accountancy College Ltd.
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Contents
PAGE
INTRODUCTION TO THE PAPER FORMULAE PROVIDED IN THE EXAMINATION PAPER CHAPTER 1: CHAPTER 2: CHAPTER 3: CHAPTER 4: CHAPTER 5: CHAPTER 6: CHAPTER 7: CHAPTER 8: CHAPTER 9: CHAPTER 10: CHAPTER 11: APPENDIX: COST ACCOUNTING AND NEW DEVELOPMENTS DECISION MAKING AND LINEAR PROGRAMMING PRICING DECISION MAKING UNDER UNCERTAINTY BUDGETING TYPES BUDGETARY CONTROL QUANTITATIVE AIDS TO BUDGETING STANDARD COSTING AND VARIANCE ANALYSIS ADVANCED VARIANCE ANALYSIS PERFORMANCE EVALUATION TRANSFER PRICING SOLUTIONS TO EXERCISES AND EXAMPLES 5 7 9 31 55 69 83 91 103 121 139 153 175 183

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Introduction to the paper

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INTRODUCTION TO THE PAPER

AIM OF THE PAPER

To develop knowledge and skills in the application of management accounting techniques to quantitative and qualitative information for planning, decision-making, performance evaluation and control.

OUTLINE OF THE SYLLABUS

1. 2. 3. 4. 5. Cost accounting techniques. Decision-making techniques including risk and uncertainty. Budgeting techniques and methods. Standard costing systems. Performance appraisal including financial and non-financial measures.

FORMAT OF THE EXAM PAPER

The syllabus is assessed by a three hour paper-based examination. The examination consists of 5 questions of 20 marks each. All questions are compulsory.

FAQs
How has the exam format changed and what impact will that have on the paper?
The paper has moved to having five 20 mark questions rather than four 25 mark questions. This move has been, it appears, to improve pass rates. Initial evidence would suggest that this will be the case. The questions will become less complex and there will be less emphasis on the discursive elements of answers and more emphasis on computation. The downside for students is that there will be more time pressure due to the fact that five separate scenarios must be understood during the limited time of the exam. On balance this is a good thing for students in future diets.

What is the skills set that a student must bring to the paper?
As a student approaching this paper the basic requirement is an ability to understand and compute the differing techniques and methods in the syllabus. In addition there is a need to understand the scenario and critically be able to write in relation to the scenario and whatever the numbers you have already calculated.

What impact will there be of having a new examiner on this paper?

There should be little or no impact of having a new examiner on the well prepared student. The style and content of the questions will change to some degree but the new examiner is given the same remit as the previous examiner.

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Formulae provided in the examination paper

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FORMULAE & TABLES PROVIDED IN THE EXAMINATION PAPER

FORMULAE SHEET

Learning curve Y ax
b

Where: y = average cost per batch a = cost of first batch x = total number of batches produced b = learning factor (log LR/log 2) LR = the learning rate as a decimal

Regression analysis y
a bx

b n xy x

a
r

y n x x
2

y2

b x n n

n xy x y
n x
2

x2 n y2

Demand curve P a bQ b change in price change in quantity

a price when Q 0

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Chapter 1

Cost accounting and new developments

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CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS

CHAPTER CONTENT DIAGRAM

Costing methods

Absorption costing

Activity based costing

Other costing methods

H H H

Full cost per unit Issue: Arbitrary cost allocation Solution: Activity based costing

H H H

Accurate costs

product

H H

Life cycle costing Target costing

Swap cost units with cost pools Swap OARs with cost driver rates

Throughput accounting

Environmental Accounting

H H H H

Return per factory hour Cost per factory hour Throughput ratio (TPAR) accounting

H H

Costing methods Reasons for use

Decision making

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CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS

CHAPTER CONTENTS
ABSORPTION COSTING ------------------------------------------------ABSORPTION COSTING A REMINDER TRADITIONAL OVERHEAD ANALYSIS STEPS USING ABSORPTION COSTING CRITICISMS OF ABSORPTION COSTING: RECENT CHANGES IN MANUFACTURING A REVISED ANALYSIS ABC STEPS USING ABC CONDITIONS UNDER WHICH ABC IS MOST APPROPRIATE BENEFITS AND LIMITATIONS

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12 12 12 13 13 14 14 17 17

ACTIVITY BASED BUDGETING (ABB) ---------------------------------THROUGHPUT ACCOUNTING ------------------------------------------BASICS RATIONALE KEY TERMINOLOGY CONCEPTS UNDERPINNING THROUGHPUT ACCOUNTING FACTORS AFFECTING THE VALUE OF THROUGH ACCOUNTING PUT STEPS IN THROUGHPUT ACCOUNTING LIMITATIONS OF THROUGHPUT ACCOUNTING

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19 19 19 20 20 20 21

TARGET COSTING-------------------------------------------------------TRADITIONAL COSTING SYSTEMS TARGET COSTING STEPS CLOSING A TARGET COST GAP IMPLICATIONS OF USING TARGET COSTING

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22 22 23 24

LIFE CYCLE COSTING---------------------------------------------------COMPARISON OF LIFE CYCLE COSTING AND TRADITIONAL MANAGEMENT ACCOUNTING

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25

ENVIRONMENTAL ACCOUNTING --------------------------------------INTRODUCTION TYPES OF ENVIRONMENTAL COSTS M ANAGING ENVIRONMENTAL COSTS ENVIRONMENTAL COSTS STRATEGIES METHODS FOR ACCOUNTING OF ENVIRONMENTAL COSTS

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28 28 29 29 29

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CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS

ABSORPTION COSTING Absorption costing a reminder

The linking of all production costs to the cost unit to prepare a full cost per unit.

Uses 1. Stock Valuation 2. Pricing decisions 3. Budgeting

Traditional overhead analysis

Overhead cost item

Cost Centres

Cost Units

Steps using absorption costing

The steps using absorption costing are: 1 Overhead costs are collected in various cost centres Allocation: Specific overhead costs directly relating to individual cost centres, for example, supervision, indirect materials. Apportionment: General or common overhead costs like rent, heating, electricity are incurred as a whole item by the company and therefore have to be distributed to cost centres on some sharing bases like floor area, machine hours, number of staff etc 2 Overhead absorption is achieved by means of a predetermined Overhead Absorption Rate. Budgeted Overheads
a. Overhead Absorption Rate =

Budgeted Level of Activity * * Activity levels generally used by examiners are number of units, labour hours or machine hours, which means overheads are charged to units on these bases. Number of Units: Labour Hours: Machine Hours: b. Absorbed overheads Single product environment Manual manufacturing operations Mechanical manufacturing operations = OAR x Actual Activity

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CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS

Example 1 2P2D Ltd

2P2D Ltd produces 2 products in 2 departments. Relevant product information is: Direct material cost () Direct labour cost in Department X Time per unit in Department X (Hours) Direct labour cost in Department Y Time per unit in Department Y (Hours) Budgeted number of units Product A 20 20 4 25 5 2,000 Product B 35 30 6 35 7 1,000

() ()

The labour rate is 5 per hour in each department. The Budgeted Departmental Overheads are: Department X Department Y Required: Calculate the cost/unit using: (a) (b) (c) Separate OARs for each department, based on labour hours. An overall OAR, based on labour hours. Discuss the differences. 18,000 6,500

Criticisms of absorption costing

Criticisms of absorption costing are: H H H A big amount of guess work in relating overhead costs to the products. Inappropriate bases to link overheads to products Can only work in single product and simple manufacturing environments

Recent changes in manufacturing

The reason for the increasing inaccuracy of absorption costing is due to two basic issues: 1. 2. Increased production complexity. Increased proportion of overhead costs.

Production complexity
A wide variety of production processes have become more complex in recent years in a number of ways: 1. Flexible manufacturing systems allow for a number of widely differing products to be produced on the same machinery. Absorbing overhead on a simple volume base is unlikely to reflect the differing overhead costs incurred by each product.

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CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS 2. Fast product development may mean that a number of differing iterations of the same product may be produced in quick order. With such products having differing production volumes again a volume base is unlikely to work. Wider product ranges lead to a more complex cost analysis.

3.

Increased proportion of overhead costs

Overheads have increased in importance as a percentage of total costs due to both the substitution of direct labour with indirect labour as companies mechanise to a greater degree. Also the increased production complexity outlined above has given rise to increased costs for such disciplines as production planning and logistics.

Increased proportion of support services costs

Activity based costing also introduces the important aspect that cost are incurred in selling and distributing a product and the cost of servicing customers are often more important than production therefore an accurate cause effect relationship should be established as to what generates the cost and what is the real impact of this cost on the volume of units sold.

A revised analysis ABC

Overhead Cost Item

Cost Pool

Cost Unit

Steps using ABC

The steps involved in ABC are: 1. 2. 3. Identify an organisations activities. Collect the cost of each activity into what is called cost pool (equivalent to cost centre under traditional costing). Identify the factors which determine the size of the costs of an activity. These are called cost drivers. Activity Ordering Material handling Production scheduling Despatching 4. Possible Cost Drivers number of orders number of production run number of production run number of despatches

Assign the cost of activities to products according to the products demand for activities.

Cost Pool is an activity that consumes resources and for which overhead costs are identified and allocated. For each cost pool there should be a cost driver. Cost Driver is any factor which causes a change in the cost of an activity.

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