Upload
zainabhaji-ahmed
View
214
Download
0
Embed Size (px)
Citation preview
8/3/2019 3-3_2003_dec_a
1/15
Answers
8/3/2019 3-3_2003_dec_a
2/15
8/3/2019 3-3_2003_dec_a
3/15
15
Part 3 Examination Paper 3.3
Performance Management December 2003 Answers
1 (a) NWEC Ltd
Budgeted Profit and Loss Statement for year to 30 November 2004
Amusement Park admission receipts:
One-day pass
Adults: 8,696,0641418 years, senior citizens 3,261,024
Under 14 years 4,348,032
Two-day pass
Adults: 19,566,144
1418 years, senior citizens 7,337,304
Under 14 years 9,783,072
52,991,640
Other revenue Income from traders 1,044,000
Total revenue park 54,035,640
Operating costs 39,104,000
Budgeted profit of park 14,931,640
Hotel income 9,110,400Hotel operating costs 8,268,000
Budgeted profit of hotel 842,400
Total budgeted profit 15,774,040
Workings:
No. of Visitor days for year to 30 November 2004 = 2,090,400
One-day passes = 2,090,400 x 25% = 522,600
Two-day passes (2,090,400 x 75%)/2 = 783,900
Admission fees applicable from 1 December 2003.
(increased by 4% per annum).
Category of visitor:
One-day pass () Two-day pass ()Adults 4160 6240
1418 years; senior citizens 3120 4680
Under 14s 2080 3120
(b) A two-way data table shows the results of combinations of different values of two key variables. In this case, the table enables
the management of NWEC to view the net profit or loss for each of a range of combinations of levels of admission to the park
and hotel occupancy. A spreadsheet data table tabulates the results of sensitivity analysis i.e. the outcome values when one
or two values are changed. The use of a data table enables the management of NWEC to quickly assess the impact on
profitability of changes in the number of visitor days to its amusement park and/or in the level of hotel occupancy. This table
indicates to management that for a net loss of 510,670 to occur within the year to 30 November 2004, not only would the
number of visitor days sold have to decrease by 25% but also hotel occupancy would have to fall to 40% (by 331/3% of the
previous years level). The best possible outcome is a profit of 28,649,968 which would arise if visitor days to the park
increased by 20% and the hotel occupancy rate also increased to 75% from 60%. Most decisions are quite complex,
involving a range of different input values. The management of NWEC can perform what-if analysis, which will improve thequality of decision-making within the organisation.
8/3/2019 3-3_2003_dec_a
4/15
16
(c) (i) The range of possible outcomes using the probability estimates given in the question and the values contained within
Appendix 1 are shown in the following table together with the expected value of net profit.
% Change in Probability Hotel Probability Combined Net Profit Expected Value
Visitor days Occupancy Probability of net profit
+10% 020 75% 010 0020 23,350,804 467,016
60% 060 0120 21,073,204 2,528,784
45% 030 0060 18,795,604 1,127,736
0% 060 75% 010 0060 18,051,640 1,083,098
60% 060 0360 15,774,040 5,678,654
45% 030 0180 13,496,440 2,429,359
15% 020 75% 010 0020 10,102,894 202,058
60% 060 0120 7,825,294 939,035
45% 030 0060 5,547,694 332,862
1000 14,788,602
(ii) The use of expected values takes into account the relative likelihood of each of the possible outcomes occurring. The
expected value of 14,788,602 is not one of the potential outcomes in the table, but is the weighted average of those
outcomes. The use of expected values by the management of NWEC implies that they have a risk-neutral attitude. A risk
neutral decision-maker will ignore the variability in the range of potential outcomes and will be concerned only with the
expected value of outcomes.
(d) The management of NWEC could choose from the following list of criteria relating to service quality. As required by the
question, a measure and mechanism for measurement is also provided.
Appearance the appearance of staff reflects the image of the hotel.
Responsiveness staff responsiveness assumes critical significance in the hotel industry. The time taken to deal with
queries by reception staff.
Comfort room facilities such as air-conditioning, tea/coffee-making and cold drinks facilities.
Availability the in-room availability of office facilities such as e-mail, facsimile and access to photocopying.
Cleanliness the cleanliness of all facilities within the hotel.
Safety measures the frequency of inspections made regarding safety equipment within the hotel and compliance with
legislation.
Customer surveys would be an appropriate mechanism for measurement of each of the foregoing measures with the exception
of safety which management should measure by inspection of internal records.
(e) Management could consider taking some of the following actions in order to maintain and improve the profitability of the
amusement park:
The current structure regarding admissions is limited to the sale of either one-day or two-day passes. Perhaps, a wider
choice of tickets available for purchase by visitors might encourage more frequent visits by individual visitors. For
example, many visitors might welcome the opportunity to purchase season tickets which would allow them to visit the
park at any time during the year. Consideration could also be given to discounted family tickets and twilight tickets for
afternoon/evening visitors. The latter would also help maintain the number of visitors throughout any given day since
the late arrival of such visitors would offset those who left after spending the morning and afternoon at the park.
The amusement park is situated in a rural area which may deter potential visitors to the park who are either unable todrive or do not have their own means of transport. Management should consider the provision of a transport service
from the nearest towns/cities to the amusement park. This might also lead to a reduction in the number of vehicles at
the amusement park leading to improved access and improved levels of safety.
The company is expected to incur total operating costs amounting to 47,372,000 during the year to 30 November
2004. Management should give consideration to instituting a formal programme of cost reduction. The focus of such a
programme is upon the need to reduce costs below the previously accepted norm whilst simultaneously avoiding a
reduction in either quality or effectiveness. If NWEC has a loose culture regarding cost-consciousness, there may well
be scope for significant savings to be achieved.
It is noticeable that the company does not have any revenues from advertising. By the very nature of its business, NWEC
is well positioned to raise such revenues from those organisations wishing to advertise their goods and services to the
customers that visit the amusement park.
8/3/2019 3-3_2003_dec_a
5/15
17
(f) The distinguishing feature of Strategic Management Accounting (SMA) is that it considers the relationship of the organisation
with its external business environment. It focuses attention on suppliers, customers and competitive rivals. Information may
be quantitative or qualitative in nature, and some information will be of a non-financial nature. For a long time there have
been criticisms of the information provided by management accountants as having an inward-looking perspective.
The development of a strategic management accounting system could provide extremely valuable additional information for
use by the management of NWEC. This value lies in the fact that the information is forward-looking and should focus on the
organisation and its external business environment. Such information will therefore focus on potential issues of importance
to the stakeholders of the organisation, in particular, its suppliers, customers and competitive rivals.
When management implement a chosen strategy they are seeking to derive a sustainable competitive advantage, and this
process will be aided by the information gathered within a strategic management accounting system. Virtually all organisations
are subject to environmental change and in this respect NWEC is no exception. Thus it is critical that all aspects of a business
are monitored so that a holistic approach is taken when strategic plans are being developed. The strategic management
accounting system should be capable of coping with changes that can and will inevitably occur in a dynamic business
environment. Hence it is crucial that changes such as the emergence of a new competitor, are detected and reflected within
strategic plans at the earliest opportunity.
If implemented, it is vital that a strategic management accounting system provides information that is relevant and reliable
therefore enabling the management of NWEC to make correct decisions. This is critical to any business given that decisions
of a strategic nature affect the entire organisation and are generally irreversible in the short-term, and quite often long term.
Thus managers throughout NWEC should receive information that will enable them to take the right options thereby improving
the overall position of the organisation. In this regard it is essential the managers be provided with information, which relates
to every aspect of NWEC and looks at its position relative to the entire industry in which it operates. This will enable dueconsideration to be given not only to the strengths and weaknesses of the NWEC but also to the opportunities and threats
facing it.
There is no doubt that a strategic management accounting system, by providing information that facilitates better planning,
control and decision making would make a major contribution to the longer term development of NWEC.
2 (a) The Fitzgerald et al framework proposes six dimensions of performance which are controlled by service industries. Their
propositions include that two of these, namely financial performance and competitiveness are the results of actions previously
taken and reflect the success of the chosen strategy. The remaining four dimensions of quality, flexibility, resource utilisation
and innovation are factors that determine competitive success now and in the future. The performance of BLA Ltd can now
be analysed under this framework.
(i) Financial performance
Summary Profit and Loss Account for the year ended 31 October 2003
Budget Actual
000s 000s
Fee income 6,075 6,300
Costs:
Consultants salaries 2,025 2,025
Bonus 90
Other operating costs 2,550 2,805
Subcontract payments 18
4,575 4,938
Net profit 1,500 1,362
It is clear that BLA has not performed as well as expected during the year to 31 October 2003. Whilst client income is
above budget, other operating expenses reached a level which is more than 10% higher than the budget for the year,
and thus it would be extremely useful to have a more detailed breakdown of other operating expenses for the year.
Consultants have earned an aggregate bonus of 90,000 (42,000 40,500) x 150 x 40% in respect of activity above
budgeted levels. Payments to subcontractors amounted to 18,000. Actual profit amounts to 1,362,000 against a
budget of 1,500,000. It would be extremely useful to see the results of the previous two years in order to assess
whether there are any discernible trends in revenues and costs. The budget for the following year should be reviewed
in the light of the actual performance of this year with particular reference to checking the footing of the assumptions
upon which it has been prepared.
(ii) Competitiveness
Competitiveness may be measured in terms of market share or sales growth and the relative success in obtaining
business from enquiries made by customers. The turnover of BLA Ltd for the year to 31 October 2003 is above budget.
Again it is desirable to see the results of recent years since it might well be the case that BLA Ltd has achieved steadygrowth which is indicative of a high level of competitiveness in future years. BLA provided 1,200 consultations on a
no-fee basis with a view to gaining new business. Also, during the year BLA consultants provided 405 non-chargeable
remedial consultations. Both of these non-chargeable activities might be viewed as initiatives to increase future levels
of competitiveness.
8/3/2019 3-3_2003_dec_a
6/15
18
It is useful to look at the extent to which BLA Ltd were successful in converting the enquiries received from both existing
and new client enquiries into new business. The percentages are as follows:
Budget Actual
Conversion rate from enquiries
New clients 360% 267%
Repeat clients 500% 700%
70% of enquiries from the existing client base resulted in additional consultancy work for BLA Ltd. This is indicative of
strong customer loyalty indicating that existing clients are satisfied with the service provided. However, the company wasunable to fare as well with regard to enquiries from potential first time customers, only achieving a conversion ratio of
267%, which is approximately 74% of the intended number of first time clients that were budgeted for. This indicates
that there is probably room for improvement in the ways in which BLA Ltd deals with enquiries from prospective clients.
The company should review its marketing strategies with a view to improving its conversion ratio.
In absolute terms new business was approximately 78% below budget whereas repeat business was 210% above
budget.
As regards the nature of the chargeable activities undertaken by the consultants it can be seen that Exterior design is
146% below budget, whereas Interior design and Garden design are 64% and 351% above budget.
(iii) Service quality
Quality of service is the totality of features and characteristics of the service package that bear upon its ability to satisfy
client needs. Flexibility and innovation in service provision may be key determinants of service quality. To some extent
the increase in the number of complaints and non-chargeable consultations associated with the remedying of thosecomplaints is indicative of a quality problem that must be addressed. This problem needs to be investigated. BLA Ltd
only provides advice to clients and only recommends contractors when asked to do so by clients. It would be interesting
to see how many of the complaints related to recommendations made by BLA Ltd. Assuming consultants could have
otherwise undertaken chargeable work, the revenue foregone as a consequence of the remedial consultations was
60,750. Client complaints received during the year were nearly double the budgeted level. Also the number of remedial
consultations was 405 against a budgeted level of only 45, which is exactly nine times higher than budget! Perhaps
BLA Ltd should review and, if necessary, limit the amount of remedial consultancy provided to any one particular client.
The business development consultations can be viewed as an innovative measure with a view to gaining additional
business. It is noticeable that during the year ended 31st October 2003 retired consultants working on a subcontract
basis undertook 120 consultations, each of which was of a non-chargeable nature. It is highly unlikely that the work
undertaken by the retired consultants was in nature of Business Development Activity as such work would invariably be
undertaken by the consultants employed on a full-time basis by BLA Ltd. Moreover, given that the actual number of
complaints during the year totalled 630 and that BLA consultants themselves undertook 405 remedial consultations, itwould be reasonable to assume that the retired consultants undertook further remedial consultations and/or work that
related to complaints from clients.
It would be extremely useful to have a detailed analysis of the client complaints. In the scenario we were told that BLA
only recommends contractors that undertake the three types of work when requested to do so by clients. In this regard
it is important to recognise that a potential problem often exists where one party provides advice and another party is
engaged to perform duties which relate to the provision of that advice.
(iv) Flexibility
Flexibility may relate to the company being able to cope with flexibility of volume, delivery speed or job specification.
Hence, flexibility might be substantiated by looking at the mix of work undertaken by the consultants during the year.
The following table gives a comparison of actual and budgeted consultations by category of consultant.
Consultations by category of consultancy service
Budget % Actual % Increase/(decrease)Exterior Design 400 329% (71%)
Interior Design 400 410% 10%
Garden Design 200 261% 61%
It is a deliberate policy of BLA Ltd to retain 45 consultants thereby maintaining flexibility to meet increasing demand.
The delivery speed will be increased as a consequence of the retention of consultants. It would appear that a change
has occurred in the mix of consultants which may well be a response to changing market requirements. Again, it would
be useful to see recent years statistics in order to consider trends but notably garden design looks to be a growth area
hence the three new consultants recruited during the year. The mix of consultants should be such that BLA Ltd can cope
with a range of job specifications. The fact that links have been retained with retired consultants will give an added
dimension of flexibility in times of very heavy demand upon its consultants.
(v) Resource utilisation
Resource utilisation measures the ratio of output achieved from those resources input. In this scenario the mean numberof consultations per consultant may be used as a guide.
8/3/2019 3-3_2003_dec_a
7/15
19
Average consultations per consultant
Budget Actual Increase/(decrease)
Exterior Design 900 922 24%
Interior Design 900 957 63%
Garden Design 900 912 13%
It is interesting to note that all categories of consultant are being utilised above budgeted levels. Consequently an
aggregate bonus amounting to 90,000 was paid in respect of the year ended 31 October 2003. There are potential
problems if the quality of the service provision is falling. In this regard it would be useful to have more detailed analysis
of the client complaints in order to ascertain whether a large proportion relate to any one category of consultancy and/or
contractor. BLA Ltd has adopted an innovative approach that requires consultants to undertake non-chargeable business
development consultations which have at their heart the intention of generating new business. Hence in the immediate
sense there is a trade-off between resource utilisation and innovation.
(vi) Innovation
Innovation should be viewed in terms of its impact on financial performance, competitiveness, service-quality, flexibility
and resource utilisation in the short, medium and long term. Certainly the non-chargeable activity in terms of business
development is an innovative feature within the business of BLA Ltd, as is the non-chargeable remedial consultancy
provided to clients who experience problems at the commencement of building works. The acquisition of state of the
art business software is by its very nature innovative. The result of its use is reflected in the significant increase of
351% above budget achieved in garden design consultations. This has probably enabled BLA Ltd to differentiate its
services from those of its competitors and enhance its reputation. Certainly the management of BLA Ltd will be hoping
for a similar increase in business as a consequence of the use of the software by its external and interior designconsultants. The management should ensure the introduction of the software has not caused the increase in the number
of complaints received.
(b) In establishing targets, the importance of individuals taking ownership of the standards has long been established: this is
often facilitated by the adoption of a budgetary system based on employee participation. This is also considered to be
beneficial to the organisation since it alleviates, or at the very least reduces, many of the dysfunctional consequences
associated with particular control models. In particular, managers who participate in the standard-setting process are more
likely to accept the standards set, feel less job-related tension and have better relationships with their superiors and
colleagues. Participation does, however, provide opportunities for the introduction of budgetary slack in order that any
subsequent monitoring of activities presents a favourable outcome.
Budgets need to be realistic enough to encourage employees to perform, but not set at levels so high that they are
demotivated. The challenge to management lies in finding the balance between what the company views as achievable and
what the employee views as achievable as this often proves to be a source of organisational conflict.
It is important that the standards of performance measurement chosen by management facilitate a fair comparison across all
similar business units and that equity is seen to prevail in measuring the performance of those units. There may be
circumstances where some business units have an inherent advantage unconnected with their own deliberate initiatives. For
example, some business units will be subject to higher levels of environmental uncertainty than others. In situations where
higher levels of uncertainty exist, there will be a need for greater reliance to be placed on subjective judgment in appraising
performance, with consequently less reliance being placed on objective, financial data. It would be inappropriate and
inequitable to measure the performance of two completely different business contexts in an identical manner.
3 With changes in business in recent years the information needs of management have expanded significantly both in terms of scope
and variety. Criticism of management accounting made by some commentators has arisen from the view that managers are
required to make decisions in an increasingly complex business environment, and yet they are supplied with information by their
organisations internal management information systems which is inadequate for that purpose.Standard costing was developed to meet the requirements of a traditional manufacturing environment. If standard costing is to
provide an effective means of cost control then it is critical that attainable standards are set in terms of agreed levels of price and
performance. Standard costs are compared with actual costs for the purpose of ascertaining variances. Such variances are then
invariably broken down into their respective price and quantity components. It should be recognised that the ascertainment of
variances is only the first stage in assessing performance. Variances must be analysed in depth, in order to establish whether they
are significant, whether they are controllable, and if so where the responsibility for the variance lies. The analysis of variances
facilitates the validation of the current standards and also improvements in methods for establishing standards in the future.
Improvements in performance management may be obtained via the adoption of a planning and operational approach to variance
analysis, particularly in situations where the product mix is relatively stable.
During recent years many commentators including Kaplan and Johnson have put forward the view that standard costing variance
analysis should no longer be used as a basis for either cost-control or the evaluation of performance in the modern manufacturing
environment. Such writers have expressed the view that the use of standard costing variance analysis may lead to behaviour, whichis incompatible with those strategic manufacturing objectives that must be achieved by companies, in order that they flourish in
todays intensely competitive international business arena. There is a growing consensus that if organisations wish to compete
effectively in such a competitive climate, they should adopt strategies which are primarily aimed at satisfying their customers. This
requires a concentrated focus upon quality, time and innovation. There is a widespread view that such critical success factors can
best be achieved by the adoption of a Total Quality Management programme.
8/3/2019 3-3_2003_dec_a
8/15
20
The characteristics of a total quality programme should include the following:
The establishment of corporate values that focus the attention of the entire organisation on the need for the total satisfaction
of all customers.
All members of the organisation are actively involved in continually improving the processes and systems under their control
and each person takes ownership of the responsibility for his or her own quality assurance.
Participation of all employees within the organisation is actively sought and encouraged.
Significant investments may be made in the training and education of staff to aid the realisation of their potential.
Quality circles are established to help ensure that their work is defect free.
Both suppliers and customers are actively involved in the process of improvement.
Process redesign is used to simplify processes, systems, procedures and the organisation itself.
When a product is designed, its specification should consider those factors which will minimise future rectification costs. The
production methods used should be as straightforward as possible and utilise the skills and resources possessed by the
organisation. It is highly significant that in the modern manufacturing environment it is often observed that approximately 90% of
the production costs of a product are determined in its design phase. Thus effective performance management requires the
monitoring of costs and revenues over the whole life cycle of the product. Traditional standard costing and variance analysis may
only focus upon production costs over a period of one month, and hence this is viewed by many commentators as being of little
relevance and rather myopic. Ensuring that quality factors have been correctly engineered into the design of products may therefore
only be apparent when costs are reported on a life-cycle basis.
An information system is needed to enable management to measure the success of those procedures adopted to ensure quality. It
is vital that such systems should measure both monetary and non-monetary factors. Quality can be measured in terms of its impact
upon profit via costs incurred and revenues generated. An example of a monetary measure would be the costs of rework whereas
non-monetary measures would include defect rates, customer complaints and yield statistics. Over time, the pre-eminence of
financial measures may diminish as non-financial measures to account for strategically important factors are developed. Due
recognition should be given to the fact that variance analysis resulting from the use of traditional standard costing systems can
inhibit quality. For example, favourable material price and labour rate variances can arise as a consequence of the use of lower
quality resources. However the use of poorer quality inputs to any process will often precipitate a reduction in the quality of output.
In the same vein, the use of efficiency and usage variances concentrate on the quantity of output from a given level of input, not
the quality. Thus standard costing concentrates upon quantity and ignores other strategically important factors such as quality,
which contribute to effectiveness.
By way of contrast, the measurement and reporting of quality is central to the operation of a TQM philosophy. Quality costs areclassified as prevention costs, appraisal costs, internal failure costs and external failure costs.
Prevention costs are the costs incurred to reduce appraisal costs to a minimum. Examples of prevention costs include the use of
quality circles aimed at achieving process improvements and the cost of regular staff training programmes.
Appraisal costs are the costs incurred for activities such as inspecting and testing, in initially ascertaining and ensuring
conformance of the product to quality requirements. Examples of appraisal costs include the cost of quality control staff carrying
out inspection checks on the receipt of materials and the cost of test equipment.
Internal failure costs are the costs arising from inadequate quality before the transfer of ownership from supplier to purchaser.
Examples of an internal failure costs would be the cost of scrapped production and the costs of rework.
External failure costs are the costs arising from inadequate quality discovered after the transfer of ownership from supplier to
purchaser. Examples include costs associated with recalled products, free replacement of goods and the delivery costs relating to
replacements.
There are a number of reasons which support the view that there is little benefit in running both a total quality programme and a
standard costing system simultaneously. These include the following:
Predetermined standards conflict with the philosophy of continual improvement which is at the heart of a total quality
management programme. There is a danger that the use of such standards will create an organisational mind-set focused
upon the attainment of the standards as opposed to continual improvement.
Standard costing is best suited to a stable, standardised and repetitive environment. However it is probable that continual
improvements will alter work methods and processes thus creating a constantly changing environment in which the use of
standard costing might be inappropriate.
The use of attainable standards, which contain an allowance for inefficiency, is diametrically opposed to the elimination of
waste which is a major component of any total quality management programme.
Under a standard costing control system, managers are made responsible for the variances relating to that part of an
organisations activities which is under their control. Standard costing variance measurement is primarily focused upon costcontrol which could prove detrimental to the level of quality achieved throughout the organisation. One of the objectives of a
total quality management programme is to make all personnel aware of and take ownership of the responsibility for the
delivery of quality products to the customer.
8/3/2019 3-3_2003_dec_a
9/15
21
A continuous improvement environment requires a constant effort to do things better as opposed to attempting to achieve an
arbitrary standard based upon the assumption that prevailing conditions will remain static for a period of time.
With regard to largely automated production systems it can be argued that use of statistical quality control can make the
production processes extremely consistent and reliable such that variances no longer arise. If this view is held then it follows
that the focus of attention should be switched to the design phase of the product, as this is where the vast majority of costs
are effectively committed.
In spite of the apparent persuasiveness of these criticisms, it can be argued that the basic principle of standard costing variance
analysis remains sound and that it can remain valuable in a Total Quality Environment. Reasons supporting the continuedusefulness of standard costing include the following:
Standard costing can still be a valuable aid to planning in a TQM environment where budgets will still require quantification.
For example, standards can be set for the planned level of quality costs to be incurred during the forthcoming period.
Whilst work teams need real-time quantitative feedback, the provision of periodic financial information via the standard
costing system is valuable in that informs them of the financial consequences of their actions.
Whilst it is undeniable that the emphasis of standard costing is upon cost control and that management need to measure
performance via a range of appropriate performance indicators, cost control nevertheless remains an important consideration,
albeit one of many.
There is no reason why existing standards should not be used as the basis in the construction of a cost for a new product.
In relation to the pricing of products, target costs can be compared with current standard costs. Inevitably there will be a cost
gap which management can then take the necessary steps to reduce or even eliminate using techniques such as valueengineering.
In manufacturing industries in many different countries, overhead costs are volume-related. Thus it remains possible that
standard costing variance analysis still has a significant role to play in cost management.
In conclusion, it would appear reasonable to suggest that the fundamental principle of accounting control incorporated in standard
costing systems remains sound. Many organisations wish to retain the atmosphere of cost-consciousness that is arguably the most
important benefit derived from the use of a standard costing system. However, such organisations need to recognise that they face
the challenge of adapting their systems in order to meet the changing requirements of modern manufacturing industry.
4 (a) Benchmarking has been defined as the establishment, through data gathering, of targets and comparators through whose
use relative levels of performance (and particularly areas of underperformance) can be identified. By the adoption of identified
best practices it is hoped that performance will improve.
A major problem facing the management of INA Ltd lies in the accessing of information regarding the activities of a competitor
firm that may be acknowledged to display best practice. Internal benchmarking i.e. using another function within the same
firm as the standard can help in the avoidance of the problems of information access, but that clearly limits the scope of what
can be achieved. The most common approach is process benchmarking, where the standard of comparison is a Best Practice
firm which may be entirely unconnected with the benchmarking organisation and not even operating within the same
industry.
In this case the company is concerned with the processes by which its purchasing department establish and achieve targets.
It is highly probable that the best yardstick for comparison would appear to be another organisation that is highly regarded
for its management of such activities.
The objective is to improve performance. This is best achieved by means of the sharing of information which should prove of
mutual benefit to both parties to the benchmarking programme. As a result of receiving new information each party will be
able to review their policies and procedures. The very process of comparing respective past successes and failures can serveas a stimulus for greater innovation within each organisation.
To evaluate the operational performance of the purchasing department team the main contribution of benchmarking will be
to establish a basis for targets which reflects the performance of an organisation which displays Best Practice with regard to
purchasing activities. As a direct consequence of a comparison of existing standards with the Best Practice organisation,
managers can focus upon areas where improvements can be achieved and evaluate measures to help attain those
improvements.
A principal benefit that will be derived by INA Ltd as a result of undertaking a successful programme of benchmarking will
be the identification of areas where cost savings are possible. Hence the levels of cost of sales and operating expenses can
be reduced leading to increased profitability. Another benefit will be the setting of more realistic purchasing targets that will
result in improved budgeting. The improved performance of the purchasing department personnel will serve as a better
platform for the introduction of initiatives such as, for example, performance related pay for the personnel within the
purchasing department.
8/3/2019 3-3_2003_dec_a
10/15
(b) It is critical that detailed planning of the work to be undertaken takes place if the programme of benchmarking is to be
successful. In order to collectively benchmark the purchasing department as a whole, the company must first review and
assess current practices. Of fundamental importance to the programme is the need to define measurable targets and
determine how those targets are going to be measured in quantitative terms. This is critical since benchmarking will be
ineffective without a reliable form of measurement. Appropriate targets for use within INA Ltd might relate, for example, to
the cost of sales as a percentage of turnover, costs of inventory, amount of discounts obtained, the number of stock-outs, the
number of emergency orders placed, the costs per order, the overall costs of the purchasing department.
At the outset it should be acknowledged that there is a need to incur significant costs in terms of management time that needs
to be invested in the benchmarking programme. However it is quite possible that considerable benefits will be realised as a
result of the comparison of the activities of the purchasing department with that of an organisation that exhibits Best Practice
in terms of purchasing efficiency and effectiveness. During the preliminary stages of the programme, the company will need
to give detailed consideration as to how the benchmarking exercise is to be conducted. The fundamental aim of the
programme will be to obtain comparative information in order that performance indicators may be developed. In turn, these
will be used to identify areas in which improvements can be obtained with resultant cost savings.
With all this preparation complete, the company will then need to not only identify a Best Practice firm against which to
benchmark, but having done so it must be able to persuade that firm to collaborate in the benchmarking programme and in
particular to share information. This is not an easy task to accomplish, as many organisations are reluctant to reveal
confidential information to present or potential competitors.
Once the exercise is complete INA Ltd will benefit from improved levels of efficiency and effectiveness within the purchasing
department, via better management information. In particular, improved visibility of costs incurred by the company will
facilitate better decision-making.
(c) There are a number of potential problems inherent in undertaking a programme of benchmarking. There needs to exist a
sufficient incentive for the respective parties to share information to their mutual benefit, as the success of the benchmarking
programme is dependent upon obtaining accurate information about the comparator organisation. Moreover, it is essential
that the business functions being benchmarked are similar enough to facilitate meaningful comparisons. The value of the
exercise must be sufficient to justify the cost involved. Also, it is inevitable that behavioural issues will need to be addressed
in any benchmarking programme. This is especially the case if incentive schemes are in existence and management may
measure members of the purchasing department against each other. Tactful management of the introduction of a
benchmarking programme is essential. Management should give priority to the need to communicate the reasons for
undertaking a programme of benchmarking in order to gain the full co-operation of the personnel within the purchasing
department whilst reducing the potential level of resistance to change. Management need to handle the ethical implications
relating to the introduction of benchmarking in a sensitive manner and should endeavour, insofar as is possible, to provide
reassurance to the members of the purchasing department that their status, remuneration and working conditions will not
suffer as a consequence of the benchmarking programme.
5 (a) In order to evaluate the investment, numerous issues require consideration by the management of Bennett plc. Firstly, there
was a need to incur expenditure of 200,000 on market research relating to the proposal. This expenditure constitutes a
sunk cost and therefore has been excluded from the evaluation by the finance director. It must be acknowledged that there
is no guarantee as to the precision of the estimate of market size arrived at by the market research consultancy. It is clear that
the management of Bennett plc are placing a high degree of reliance upon the consultants assessment. As the new project
requires a sizeable capital investment, the estimate of sales assumes critical significance.
22
8/3/2019 3-3_2003_dec_a
11/15
23
It is noticeable that the intended selling price of the product varies in each of years 14. This reflects the desired intention of
the board of directors to maintain a 5% share of the total market in each of the four years of the estimated life of the product.
The changes in selling price are intended to help procure this desired level of market share. There is a linear relationship
between selling price per unit and sales units. The finance director has used a price/demand relationship of P = 90
00002Q to estimate the selling price to be charged in order to achieve the required sales quantities of the product in each
year.
Quotations will almost certainly have been obtained to substantiate the capital outlay that would be required in order to enable
manufacture of the product to commence. It is highly probable therefore that the Year 0 outlay is accurate. The residual value
is more uncertain estimate which the finance director has chosen to recognise during year 5, which reflects the fact that, in
practice, such capitial items cannot be sold immediately upon cessation of such a project due to amount of time required for
de-commissioning/dismantling etc.
The requirement for the injection of working capital should also be free from material error. Any error regarding the timing of
the release of working capital will be due to the inaccuracy of the estimated life cycle of the product.
The marketing directors estimates in respect of the intended advertising campaign total 26 million in undiscounted terms.
The estimates and the phasing of this amount should be subjected to a detailed examination. If it were possible to defer some
of the expenditure, then the NPV and IRR arrived at in the forecast, and hence the projects desirability, would be improved.
An estimated variable cost of 35 per unit has been assumed to remain constant for the expected four-year life of the product.
This may be an unrealistic assumption and ignores any efficiency gains and/or benefits from learning and experience that
could arise.
The estimated fixed costs should be reviewed to ensure that they are truly attributable to the investment. These costs areforecast to remain fixed for the four-year life of the project and this may also be too simplistic an assumption.
In the scenario we are told that the finance director uses a cost of capital of 14% as a hurdle rate with which to evaluate all
such proposals. However, whether this is an appropriate cost of capital to use for this project is questionable. In theory, the
marginal cost of capital (MCC) should be used for any such project although one should acknowledge that the MCC of a given
project might itself might be difficult to ascertain. Nevertheless, given that no two projects are identical it is reasonable to
question the use of a single hurdle rate in the appraisal of all projects within Bennett plc.
The finance director chose to use two performance measures, Net Present Value (NPV) and Internal Rate of Return (IRR), in
appraising the investment. Each of these measures is based on the use of discounted cash flow analysis. When evaluating
investments with a simple cash flow profile i.e. those involving a one-off investment outlay followed by a stream of cash
inflows, both the NPV and IRR methods produce the same accept or reject decisions.
The finance director might well appreciate that an advantage which accrues from the use of the NPV method, lies in the
simplicity with which results are stated. NPV is an absolute measure of performance which produces a result expressed ins which directly reflects the changed wealth position expected as a consequence of undertaking an investment. However,
because NPV is an absolute measure of performance it does not easily allow two investments of very different scales to be
compared. By way of contrast, the Internal rate of return produces a result which is shown as a percentage, and this result
has to be compared with a required rate of return before a decision regarding whether to invest or not can be made. Since
IRR is a relative measure, it could be used by the finance director to compare returns on investment projects which differ
significantly in scale.
However, because internal rate of return (IRR) ignores the relative size of investments, it should not be used to select between
mutually exclusive projects since the project with the highest IRR might have the lowest absolute return.
The evaluation prepared by the finance director also ignores the effects of both inflation and taxation which could prove
significant given the timescales and level of investment involved.
In view of the number of variables contained in the forecast, the management of Bennett plc should apply sensitivity analysis
to the forecasted cash flows, in order to gain a more comprehensive appreciation of the financial implications of the project.
(b) Target costing should be viewed as an integral part of a strategic profit management system. The initial consideration in target
costing is the determination of an estimate of the selling price for a new product which will enable a firm to capture its required
share of the market. Then it is necessary to reduce this figure to reflect the firms desired level of profit, having regard to the
rate of return required on new capital investment and working capital requirements. The deduction of required profit from the
proposed selling price will produce a target price that must be met in order to ensure that the desired rate of return is obtained.
Thus the main theme that underpins target costing can be seen to be what should a product cost in order to achieve the
desired level of return.
Target costing will necessitate comparison of current estimated cost levels against the target level which must be achieved if
the desired levels of profitability, and hence return on investment, are to be achieved. Thus where a gap exists between the
current estimated cost levels and the target cost, it is essential that this gap be closed.
In the case of Bennett plc it is apparent that if the market research findings regarding market share has been accurately
forecast at appropriate selling prices for the four-year life of the project, then costs must be reduced from the currently
estimated level if the proposal is to be acceptable at a hurdle rate of 14%.
8/3/2019 3-3_2003_dec_a
12/15
The management of Bennett plc should be cognisant of the fact that it is far easier to design out cost during the
pre-production phase than to control out cost during the production phase. Thus cost reduction at this stage of a products
life cycle is of critical significance to business success. A number of techniques may be employed in order to help in the
achievement and maintenance of the desired level of target cost. Attention should be focused upon the identification of value
added and non-value added activities with the aim of the elimination of the latter. The product should be developed in an
atmosphere of continuous improvement. In this regard, Total Quality techniques such as the use of Quality circles may be
used in attempting to find ways of achieving reductions in product cost.
Value engineering techniques can be used to evaluate necessary product features such as the quality of materials used. It is
essential that a collaborative approach is used by the management of Bennett plc and that all interested parties such as
suppliers and customers are closely involved in order to engineer product enhancements at reduced cost.
The target cost-setting process
Source: Sakurai,H, Journal of Cost Management for the Manufacturing Industries, Target Costing and how to use it,
iii No 2, (1989)
24
Defineproductspecification
Definesalesvolume
Settargetprice
Defineinvestmentrequirement
Definerequiredprofit
Definecurrentcost
Definetargetcost
Try toclosegap
Calculatecost gap
Negotiatewithcustomer
8/3/2019 3-3_2003_dec_a
13/15
Part 3 Examination Paper 3.3
Performance Management December 2003 Marking Scheme
Marks Marks
1 (a) Admission revenue:
Use of correct prices 3
Correct passes 1
Other income (correct figure) 1
Operating costs 1Hotel income 1
7
(b) Comments on data table (on merit)
4
(c) (i) Combined probability schedule 2
Profit and loss schedule 2
Expected value (correct answer) 2
6
(ii) Likelihood of occurrence 1
Risk neutrality 1
Other relevant comments 1 3
(d) Comments re selected criteria 3
measures/mechanisms 3
6
(e) Comments on actions:
Admission passes (variants)
Cost reduction
Improve accessibility
Advertising revenues
Other relevant comments
Up to 2 marks per comment
6
(f) Explanation of strategic management accounting Up to 3
Benefits Up to 5
8
Total 40
2 (a) Comments (on merit) re:
Financial performance Up to 3
Competitiveness Up to 3Service quality Up to 3
Flexibility Up to 3
Resource utilisation Up to 3
Innovation Up to 3
Maximum 15
(b) Ownership Up to 2
Achievability Up to 2
Equity Up to 2
Maximum 5
Total 20
25
8/3/2019 3-3_2003_dec_a
14/15
Marks Marks
3 Standard costing:
Appropriateness re Performance measurement Up to 4
Inappropriateness re Performance measurement Up to 4
Need for change Up to 4
Quality improvement programmes:
Characteristics/features Up to 4
Quality costs Up to 4
Other relevant discussion (on merit) Up to 4 Maximum 20
Total 20
4 (a) Definition Up to 2
Potential benefits Up to 4
Maximum 6
(b) Need for initial review of current practices 1
Need for measurable targets Up to 3
Need for comparative information to facilitate the development
of appropriate performance indicators Up to 3
Need for management resource/time 1
Need for collaboration with excellent performer 1
Need for consideration of other relevant factors: such as suppliers
dealt with, annual spend, frequency and no of orders, order value. Up to 2
Other relevant discussion (on merit) Up to 2
Maximum 8
(c) Problems Up to 3
Recommendations Up to 3
Maximum 6
Total 20
26
8/3/2019 3-3_2003_dec_a
15/15
Marks Marks
5 (a) Market research a prediction; expenditure exclusion 1
Capital cost/residual value 05
Residual value in year 5 1
Working capital introduction/ release 05
Recognition of price and demand relationship 1
Estimation of function 2
Variable costs 1
Fixed costs attributable 1Advertising 1
NPV is an absolute measure; simplicity of result; problem of comparability 1
IRR is a relative measure; ignores the relative size of investments 1
Other relevant discussion (on merit) including:
Challenge cost of capital
Taxation ignored
Inflation ignored Up to 3
Maximum 10
(b) Explain target costing Up to 2
Diagram Up to 5
Return