P5 - Interim

Interim Assessment

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ACCA INTERIM ASSESSMENT

Advanced Performance Management

QUESTION PAPER Time allowed Reading time: 15 minutes Writing time: 3 hours This paper is divided into two sections Section A BOTH questions are compulsory and MUST be

answered Section B TWO questions ONLY to be answered Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall

JUNE 2009

Kaplan Publishing/Kaplan Financial

ACCA P5 Advanced Performance Management

© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.

Page 2 of 8 KAPLAN PUBLISHING

Interim Assessment

SECTION A

BOTH questions are compulsory and MUST be answered QUESTION 1 Prodcon plc manufactures and sells product Y which has a further expected life of four years to 30 June 20X4. In the company long-term plan the target for production/sales of product Y is 10,000 units per year. Current market predictions, however, indicate that sales of product Y in the years to 30 June 20X1, 20X2, 20X3 and 20X4 are likely to be 8,000, 7,000, 6,000 and 5,000 units respectively. It is company policy to produce on a just-in-time basis with no stock holding. Strategy changes in advertising and product design should enable the sales of product Y for the four years to 30 June 20X4 to be boosted to 10,000 units per year, thereby meeting the company long-term plan. The current estimates for product Y for the year to 30 June 20X1, based on the current volume projection of 8,000 units, are as follows: (i) Unit data

$

Selling price 1,250 Sub-assembly P (material cost) 250 Sub-assembly Q (material cost) 120 Other direct material cost 200 Conversion costs 560

The conversion costs are incurred on a dedicated production line that makes sub-assemblies P and Q and uses them with the other direct materials to produce product Y. All unit costs are variable with output except that conversion costs contain a 75% fixed element. This fixed element is directly attributable to product Y.

(ii) Total additional costs allocated to the product

Administration cost: $500,000. This is 100% fixed and contains a 30% element that is directly attributable to product Y, the balance being company fixed cost. Sales/marketing cost: $750,000. This contains a 40% element that varies with sales volume. The remaining 60% is fixed. Half of this is directly attributable to product Y and the remainder is a company fixed cost. Distribution cost: $100,000. This contains an 80% element that varies with sales volume. The remainder is a company fixed cost.



It is estimated that the proposed strategy change in advertising and product design in order to boost sales of product Y to 10,000 units per year for the four years to 30 June 20X4 would have the following implications:

• Additional advertising expenditure of $500,000, $400,000 and $200,000 in

each of the years to 30 June 20X1, 20X2 and 20X3 respectively would be incurred.

• Sub-assembly Q would be outsourced. The proposed supplier is a leader in this field and would charge $225 per unit for the sub-assembly. Prodcon plc would be able to avoid one-quarter of the variable conversion cost per unit of product Y where the outsourcing of sub-assembly Q takes place. In addition, $360,000 of the fixed production line conversion costs per year would also be avoided.

Note: Ignore the possibility of cost changes during the four years to 30 June 20X4 due to supplier price increases, wage awards, etc. Also, assume that the selling price of product Y will remain unchanged. Required: (a) Prepare a financial analysis of the situation for each year and in total and hence

determine each of the following for the four-year period to 30 June 20X4:

(i) The product-specific profit or loss which would result from the current market projections (i.e. before the proposed changes). (12 marks)

(ii) The total product-specific profit or loss which would be achieved if the

proposed strategy is implemented, and hence whether the proposed strategy should be implemented on financial grounds. (12 marks)

(b) (i) Evaluate the financial cost/benefit of the plan to outsource sub-assembly Q. (4 marks)

(ii) Comment on other arguments for and against the plan to outsource sub-assembly Q. (5 marks)

(c) Explain the procedure by which a spreadsheet model of the proposal could be used

in order to test for each of the following:

(i) The combined effect on profit of (A) sales achieved in all of the years to 30 June 20X1, 20X2, 20X3 and 20X4 being between 10,000 and 8,000 units per year in 500 unit steps and (B) the outsourced sub-assembly Q cost varying between $240 and $210 per unit in $5 steps. (3 marks)

(ii) The sensitivity of the model to errors in the estimates used for EACH of (A)

sub-assembly Q cost per unit and (B) selling price per unit where an overall net attributable profit of $1,000,000 is the minimum level at which Prodcon plc would proceed with the strategy change. (4 marks)

(Total: 40 marks)


Interim Assessment

QUESTION 2 INA Inc manufactures and distributes generic paper-based products and currently has an annual turnover of $100 million. At present, the management of INA Inc are uncertain whether the purchasing department is maximising its potential in terms of purchasing efficiency and effectiveness. The management are currently considering the introduction of a system of benchmarking to measure the performance of the purchasing department. Required: (a) Explain the term ‘benchmarking’ and briefly discuss the potential benefits that can be

obtained as a result of undertaking a successful programme of benchmarking. (6 marks) (b) Describe how a system of benchmarking could be introduced to measure the

performance of the purchasing department. (8 marks) (c) Discuss the problems that the management of INA Inc might encounter in

implementing a system of benchmarking and recommend how such problems should be successfully addressed. (6 marks)

(Total: 20 marks)



SECTION B

TWO questions ONLY to be answered QUESTION 3 Astrodome Sports Inc was formed in December 20X0 by seven engineers who comprise the board of directors of the company. The seven engineers previously worked together for ‘Telstar’, a satellite navigation company. In conjunction with one of the three largest construction companies within their country they constructed the ‘365 Sports Complex’ which has a roof that opens and uses revolutionary satellite technology to maintain grass surfaces within the complex. The complex facilities, which are available for use on each day of the year, include two tennis courts, a cricket pitch, an equestrian centre and six bowling greens. The tennis courts and cricket pitch are suitable for use as venues for national competitions. The equestrian centre offers horse-riding lessons to the general public and is also a suitable venue for show-jumping competitions. The equestrian centre and bowling greens have increased in popularity as a consequence of regular television coverage of equestrian and bowling events. In spite of the high standard of the grass surfaces within the sports complex, the directors are concerned by reduced profit levels as a consequence of both falling revenues and increasing costs. The area in which the ‘365 Sports Complex’ is located has high unemployment but is served by all public transport services. The directors of Astrodome Sports Inc have different views about the course of action that should be taken to provide a strategy for the future improvement in the performance of the complex. Each director’s view is based on his/her individual perception as to the interpretation of the information contained in the performance measurement system of the complex. These are as follows: Director (1) ‘There is no point whatsoever in encouraging staff to focus on interaction with

customers in efforts to create a ‘user friendly’ environment. What we need is to maintain the quality of our grass surfaces at all costs since that is the distinguishing feature of our business.’

(2) ‘Buy more equipment which can be hired out to users of our facilities. This will improve

our utilisation ratios which will lead to increased profits.’ (3) ‘We should focus our attention on maximising the opening hours of our facilities.

Everything else will take care of itself.’ (4) ‘Recent analysis of customer feedback forms indicates that most of our customers are

satisfied with the facilities. In fact, the only complaints are from three customers – the LCA University which uses the cricket pitch for matches, the National Youth Training Academy which held training sessions on the tennis courts, and a local bowling team.’

(5) ‘We should reduce the buildings maintenance budget by 25% and spend the money

on increased advertising of our facilities which will surely attract more customers.’


Interim Assessment

(6) ‘We should hold back on our efforts to overcome the shortage of bowling equipment for hire. Recent rumours are that the National Bowling Association is likely to offer large financial grants next year to sports complexes who can show they have a demand for the sport but have deficiencies in availability of equipment.’

(7) ‘Why change our performance management system? Our current areas of focus

provide us with all the information we need to ensure that we remain a profitable and effective business.’

As management accountant of Astrodome Sports Inc you have recently read an article which discussed the following performance measurement problems: (i) Tunnel vision (ii) Sub-optimisation (iii) Misinterpretation (iv) Short-termism (v) Measure fixation (vi) Misrepresentation (vii) Gaming (viii) Ossification. Required: (a) Explain FOUR of the above-mentioned performance measurement problems (i-viii)

and discuss which of the views of the directors (1-7) illustrate its application in each case. (12 marks)

(b) Discuss the relevance of each of the following actions as steps in trying to remedy

performance measurement problems relating to the ‘365 Sports Complex’ and suggest examples of specific problem classifications that may be reduced or eliminated by each action: (i) Focusing on and improving the measurement of customer satisfaction. (ii) Involving staff at all levels in the development and implementation of

performance measures. (iii) Being flexible in the extent to which formal performance measures are relied

on. (iv) Giving consideration to the auditing of the performance measurement system. (8 marks) (Total: 20 marks)



QUESTION 4 You are responsible for managing the preparation of all revenue and cost budgets for a motor component manufacturer. You are aware that the external environment has a significant impact on the business activity and financial performance of your company and that the current information systems are underdeveloped and ineffective in this respect. Required: (a) Identify which aspects of the external environment you are likely to consider and give

reasons for your choice. (10 marks) (b) Identify where you might find the relevant sources of information. (5 marks) (c) Suggest how an external environment information system could be introduced into an

organisation of your choice. (5 marks) (Total: 20 marks) QUESTION 5 Required: (a) Describe FOUR ways in which budgeting may be viewed as a useful management

accounting technique. (8 marks) (b) Discuss why an activity based budgeting system may be viewed as more useful than

a traditional incremental budgeting system. (6 marks) (c) Suggest reasons for the view that the major annual budget preparation exercise may

not be an effective use of business resources. (6 marks) (Total: 20 marks)


Interim Assessment

ACCA

Paper P5

Advanced Performance Management June 2009

Interim Assessment – Answers

To gain maximum benefit, do not refer to these answers until you have completed the interim assessment questions and submitted them for marking.



© Kaplan Financial Limited, 2008 All rights reserved. No part of this examination may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior permission from Kaplan Publishing.


Interim Assessment

ANSWER 1 (a) (i) Existing situation – projected product-specific profit / loss

Year to 30 June 20X1 20X2 20X3 20X4 Total

Sales/production (units) 8,000 7,000 6,000 5,000

$000 $000 $000 $000 $000

Manufacturing contrib (at $540 per unit) 4,320.0 3,780.0 3,240.0 2,700.0

Less:

Fixed conversion cost –3,360.0 –3,360.0 –3,360.0 –3,360.0

Less product-specific:

Administration cost − fixed –150.0 –150.0 –150.0 –150.0

Selling/marketing cost – variable –300.0 –262.5 –225.0 –187.5

Selling/marketing cost – fixed –225.0 –225.0 –225.0 –225.0

Distribution cost − variable –80.0 –70.0 –60.0 –50.0

Product-specific profit/loss(–) 205.0 –287.5 –780.0 –1,272.5 –2,135.0

(ii) Proposed strategy

Year to 30 June 20X1 20X2 20X3 20X4 Total

Sales/production (units) 10,000 10,000 10,000 10,000

$000 $000 $000 $000 $000

Manufacturing contrib (at $470 per unit) 4,700

Less:

Fixed conversion cost –3,000

Less product-specific:

Administration cost − fixed –150

Selling/marketing cost − variable –375

Selling/marketing cost − fixed –225

Distribution cost − variable –100

Profit/loss(–) before advertising 850 850 850 850

Less advertising cost –500 –400 –200 0

Product-specific profit/loss(–) 350 450 650 850 2,300



The proposed strategy is worthwhile on financial grounds since there is an improvement in product-specific profit of $4,435,000.

Working notes: Manufacturing contribution: For existing situation = $1,250 – (250 + 120 + 200 + (25% × 560)) = $540 For proposed strategy = $1,250 – (250 + 225 + 200 + (0·75 × 25% × 560)) = $470 Fixed conversion cost: Existing = 75% × $560 × 8,000 units = $3,360,000 Proposed = $3,360,000 – $360,000 = $3,000,000 Administration cost: Attributable element = 30% × $500,000 = $150,000 Sales/marketing cost: variable element per unit = ($750,000 × 40%)/8,000 = $37.50, e.g. for 20X1 = $37.50 × 7,000 units = $262,500 Attributable fixed element = ($750,000 × 60%)/2 = $225,000 Distribution cost: variable element per unit = ($100,000 × 80%)/8,000 = $10; e.g. for 20X1 = $10 × 7,000 units = $70,000

Attributable fixed element = Nil

(b) (i) Sub-assembly Q: Current variable cost per unit ($)

Materials element = 120 Conversion cost = 25% × (25% × $560) = 35 Total = 155 Outsourced assembly cost = 225 Net increase per unit = 70 Net increase for 10,000 units = 10,000 × $70 = $700,000 Less fixed cost saving = $360,000 Net increase per year for 10,000 units = $340,000

The outsourcing is, therefore, not viable on solely financial grounds.

(ii) The outsourcing is to enable sub-assembly Q to be made by a specialist in

the field. We are told that this will guarantee the quality of the re-designed sub-assembly.

Together with the advertising effort, this is seen as a contributory factor in the strategy which should raise sales per year to 10,000 units. As shown in part (a) of the question, the amended strategy should result in a gain of $4,435,000 over the four-year period.


Interim Assessment

We would need to evaluate what proportion of the gain could come from extra advertising alone. It is likely that the advertising and re-design (linked to outsourcing) are complementary aspects of the strategy.

In addition, the outsourcing will leave capacity available which could generate income from some other use. Disadvantages include the risk that the supplier will default on quality and/or quantity. Also, Prodcon plc may lose the skills for future development of this and other products. There may also be a penalty payment to the outsource supplier if Prodcon plc does not require the full 10,000 units of sub-assembly Q per year. (Note: This is a more comprehensive treatment than would be required from a candidate.)

(c) (i) A two-way data table should be prepared. This will use sales units and

outsourcing cost of sub-assembly Q as the key variables. Expected profit is chosen as the variable to be monitored by the data table. In this example, we would have a matrix of 35 combinations of the key variables each providing a profit value.

(ii) We are told that an overall attributable profit of $1,000,000 is to be used as

the decision criterion for proceeding with the proposed strategy. The critical level of each of the variables is the value of the variable at which the attributable profit is $1,000,000. This may be tested in the spreadsheet model. This could be done by changing the value of selling price in the model, while leaving all other variables unchanged, until a profit of $1,000,000 is observed. A one-way data table could be used to speed up the process. The procedure would then be repeated by changing the sub-assembly Q cost per unit while leaving all other variables unchanged. The sensitivity for each of selling price and sub-assembly Q cost could then be measured by comparing the critical value of the variable with its value in the original estimate.



MARKING GUIDE

Marks

(a) (i) Contribution per unit 1 Contribution for each year (4 × ½) 2 Fixed conversion cost 1 Admin cost – fixed 1 Selling/marketing cost – variable (4 × ½) 2 Selling/marketing cost – fixed 1 Distribution cost – variable (4 × ½) 2 Profit/loss for each year and layout 2 _

12 (ii) Contribution per unit 2 Fixed conversion cost 1 Admin cost – fixed 1 Selling/marketing cost – variable 1 Selling/marketing cost – fixed 1 Distribution cost – variable 1 Profit before advertising 1 Advertising cost 1 Net profit and layout 2 Decision to proceed on financial grounds 1 __

12 (b) (i) Net increase per unit from outsourcing 2 Fixed cost saving and decision 2 _

4 (ii) Points for and against outsourcing (on merit) 5 (c) (i) Two way data table explanation 3 (ii) Sensitivity explanation 4 __ Total 40 __


Interim Assessment

ANSWER 2 (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 Inc 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 serve as 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 Inc 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 performance related pay for the personnel within the purchasing department.

(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 Inc 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 significant costs must be incurred in terms of the 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 Inc 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.


Interim Assessment

MARKING GUIDE

Marks

(a) Definition of benchmarking 1 Explanation of internal, competitor and process

benchmarking

Max 3

Discussion of potential benefits Max 4 _____

Maximum part (a) 6 (b) Assessment of current practices 2 Set measurable targets (give examples appropriate to

purchasing) 2

Identify standards to benchmark against 2 Plan and implement 2 _____

8 (c) Obtaining information to benchmark against 2 Costs exceed benefits 2 Impact on staff 2 _____

6 __ Total 20 __ Marks should be awarded on merit for other valid points made.



ANSWER 3 Key answer tips: This invites discussion of many of the more theoretical aspects of business performance evaluation. In particular, candidates are invited to comment on the merits of ‘forward looking’, quality based metrics relative to the alternatives. Discussion of this central issue is particularly important to a service operation that relies almost entirely on customer satisfaction to generate profit. (a) Candidates may choose FOUR problems with performance measures from those

listed below:

Tunnel vision may be seen as undue focus on performance measures to the detriment of other areas. For example ‘There is no point whatsoever in encouraging staff to focus on interaction with customers in efforts to create a ‘user friendly’ environment. What we need is to maintain the quality of our grass surfaces at all costs since that is the distinguishing feature of our business.’

Sub-optimisation may occur where undue focus on some objectives will leave others not achieved. For example, ‘We should focus our attention upon maximising the opening hours of our facilities. Everything else will take care of itself.’ This strategy ignores the importance of a number of other issues, such as the possible need to increase the availability of horse-riding and bowling equipment for hire. Misinterpretation involves failure to recognise the complexity of the environment in which the organisation operates. Management views have focused on a number of performance measures such as ‘spend the money on increased advertising of our facilities which will surely attract more customers.’ This fails to recognise the more complex problems that exist. The town is suffering from high unemployment which may cause population drift and economic decline. This will negate many of the initiatives that are being suggested by management. This may to some extent be offset by the good transport links to the ‘365 sports complex’. Short-termism is a focus on immediate results which leads to the neglect of longer-term objectives. An example would be ‘We should reduce the buildings maintenance budget by 25% and spend the money on increased advertising of our facilities which will surely attract more customers.’ Measure fixation implies behaviour and activities in order to achieve specific performance indicators which may not be effective. For example, ‘Buy more equipment which can be hired out to users of our facilities. This will improve our utilisation ratios which will lead to increased profits.’ Problems of unemployment and lack of complaints from customers may mean that more equipment will not improve profit levels.

Misrepresentation refers to the tendency to indulge in ‘creative’ reporting in order to suggest that a performance measure result is acceptable. For example ‘Recent analysis of customer feedback forms indicate that most of our customers are satisfied with the facilities. In fact, the only complaints are from three customers – the LCA University who use the cricket pitch for matches, the National Youth Training Academy who hold training sessions on the tennis courts, and a local bowling team.’ This ignores the likely size of capacity share occupied by these three customers. In this regard it should be acknowledged that complaints represent a significant threat to the business since ‘bad news often travels fast’ and other customers may then ‘vote with their feet’.


Interim Assessment

Gaming is where there is a deliberate distortion of the measure in order to secure some strategic advantage. This may involve deliberately under performing in order to achieve some objective. For example, ‘We should hold back on our efforts to overcome the shortage of bowling equipment for hire. Recent rumours are that the National Bowling Association are likely to offer large financial grants next year to sports complexes who can show they have a demand for the sport but have deficiencies in availability of equipment.’ Ossification which by definition means ‘a hardening’ refers to an unwillingness to change the performance measure scheme once it has been set up. An example could be ‘Why change our performance management system? Our current areas of focus provide us with all the information that we need to ensure that we remain a profitable and effective business.’ This ignores issues/problems raised in the other comments provided in the question.

(b) Trying to focus on and improve the measurement of customer satisfaction

This is a vital goal. Without monitoring and improvement of levels of customer satisfaction, an organisation will tend to underachieve and is likely to have problems with its future effectiveness. Positive signals from performance measures made earlier in the value chain are only relevant if they contribute to the ultimate requirement of customer satisfaction. Tunnel vision and sub-optimisation are examples of measurement problems that may be reduced through recognition of the need for a management focus on customer satisfaction. For example undue focus on the importance of maximising opening hours may lead to lack of focus on other quality issues seen as important by customers. Involving staff at all levels in the development/implementation of performance measures People are involved in the achievement of performance measures at all levels and in all aspects of an organisation. It is important that all staff are willing to accept and work towards any performance measures that are developed to monitor their part in the operation of the organisation and in the achievement of its objectives. This should help, for example, to reduce gaming. At the sports complex an example of gaming might be a deliberate attempt to understate the potential benefits of maintaining the buildings in order to ensure that funds would be used for other purposes, such as an increased advertising budget. The directors of Astrodome Sports Inc must recognise that leisure facilities that appear dated and in a poor state of repair will cause customers to look for more aesthetically appealing alternatives. Being flexible in the extent to which formal performance measures are relied on It is best to acknowledge that measures should not be relied on exclusively for control. A performance measure may give a short-term signal that does not relate directly to actions that are taking place to improve the level of performance in the longer term. To some extent, improved performance may be achieved through the informal interaction between individuals and groups. This flexibility should help to reduce measure fixation and misrepresentation. For example, the percentage increase in the quantity of bowling equipment purchased is seen as necessarily implying increased demand for use of the bowling greens.



Giving consideration to the audit of the performance measurement system

Actions that may be taken include: • Seeking expert interpretation of the performance measures in place. It is

important that any audit is ‘free from bias’ and conducted independently on an ‘arm’s length’ basis. Thus, it is essential that such audits should be ‘free from the influence’ of those personnel involved in the operation of the system.

• Maintaining a careful audit of the data used. Any assessment scheme is only as good as the data on which it is founded and how this data is analysed and interpreted.

The above actions should help, in particular, to reduce the incidence and impact of measure fixation, misinterpretation and gaming.

For example, an audit may show that the directors of Astrodome Sports Inc are fixated on equipment availability and misinterpret this as being the key to customer volume and high profitability. The audit may also provide evidence of gaming such as a deliberate attempt to underplay the benefits of one course of action in order to release funds for use on some alternative.

MARKING GUIDE

Marks

(a) Any 4 of the performance measurement problems should be chosen

Explanation of the problem (4 × 1 mark) 4 Discussion of directors views applicable to each (4 × 2

marks) 8 __

12 (b) 4 × 2 marks on merit 8 __ Total 20 __


Interim Assessment

ANSWER 4 (a) Information areas

Customers – What are their needs and expectations? Are the needs changing? What is the potential for products and markets? Competitors – Who are they? What are they doing? Can their ideas/products be copied? Size? Pricing policy? Profitability? Market share? Legal framework – Compliance requirements to meet statutory standards e.g. safety, labelling and working conditions. Suppliers – Information is required concerning: • quality of supplier • prices • potential of new suppliers • financial viability of suppliers.

Political and environmental framework The motor vehicle industry business will be influenced by government transport policy, vehicle emission standards and the health and safety laws concerned with production methods. Financial and economic environment Business activity is influenced by general level of economic activity. Inflation rates, interest rates, foreign exchange rates and the levels of imports and exports all impact upon business. All of the above issues are likely to have consequences for the company in terms of future: • business activity levels • financial performance • production method • costs • business viability • market trends and therefore need to be considered in the preparation of budgets – they will influence the future revenues, costs and growth of the company.



(b) Sources

Market research – commissioned or generally available from secondary sources. Trade reports – magazines and conferences. Suppliers – price lists and brochures. Government reports – general reports and the occasional specific report on industrial sectors. Government statistics – economic indicators, industrial output, consumer spending, inflation rates. Newspaper and other media reports – a great deal of this information is now available on the Internet – more accessible.

(c) Implementation

• Data capture systems need to be developed with assigned responsibility for obtaining the information.

• Monitoring systems are required to ensure that new information and new information sources are identified and utilised.

• Ensure that the appropriate people receive the information that they require – avoid sending everyone all the data – may result in it being dismissed.

• Dissemination of the information via: (1) company magazine (2) e-mail/Internet (3) occasional meetings to discuss the impact of significant issues.

• May need to categorise the information as being relevant for strategic or operational decisions – that this categorisation may influence the frequency and detail required.

• Do the people preparing the budgets have the competence to interpret and incorporate the information provided into their estimates?

• Is the information distributed in its raw form or is it modified to meet the internal users specific needs?

MARKING GUIDE

Marks

(a) External environment and reason for choice 1−2 marks Max 10

(b) Source of information 1 each Max 5

(c) Introduction on a system – for each good point made 1 mark Max 5 __

Total 20 __


Interim Assessment

ANSWER 5 (a) Budgeting may be viewed as of use in planning, co-ordination, control, motivation and

performance evaluation.

As a planning aid, the budgeting process allows for the quantification of the business plan. Alternative planning scenarios may be examined and a ‘what-if’ analysis applied. This feed-forward view will enable a proposed plan to be compared with the level of achievement which is required in order to provide the level of return required by the organisation. If necessary amendments can be made in order that the agreed plan will achieve the required level of return. The co-ordination of business activities will be aided through the budgeting process. Areas of imbalance, for example between production capacity available and that required to satisfy demand, may be identified and investigated. The co-ordination process will also avoid individual members of management making planning decisions which are sub-optimal for the business as a whole. The control of business activities will be aided through the comparison of actual results against the budget plan. The variances may be investigated and corrective action taken. This process may be enhanced through the application of a flexible budgeting approach. The budget should act as a motivating device. This should be enhanced through the feeling of involvement, which participation in the budgeting process will promote. Management is more likely to identify and work toward achieving targets which it has agreed in advance. Budgets may be used as a base against which to measure actual performance. The measures may be quantitative in both monetary and non-monetary terms. Examples might be the monitoring of cash flow or the percentage of material losses incurred. The trend of variances between budget and actual may be monitored in order to help identify whether an ‘in control’ or ‘out of control’ situation exists.

(Alternative relevant uses and comment would be accepted.) (b) Advantages claimed for the use of activity based budgeting include the following:

• Resource allocation is linked to a strategic plan for the future, prepared after considering alternative strategies. Traditional budgets tend to focus on resources and inputs rather than on objectives and alternatives.

• New high priority activities are encouraged, rather than focusing on the existing planning model. Activity based budgeting focuses on activities. This allows the identification of the cost of each activity. It also allows the ranking of activities where financial constraints limit the range of activities which may be achieved.

• There is more focus on efficiency and effectiveness and the alternative methods by which they may be achieved. Activity based budgeting assists in the operation of a total quality philosophy.

• It avoids arbitrary cuts in specific budget areas in order to meet the overall financial targets. Non-value added activities may be identified as those which should be eliminated.



• It tends to increase management commitment to the budget process. This should be achieved since the activity analysis enables management to focus on the objectives of each activity. Identification of primary and secondary activities and non-value added activities should also help in motivating management in activity planning and control.

(c) Current investigation of budgeting indicates that some organisations claim that they

have abandoned the major annual budget preparation exercise. Arguments are put that a number of adverse impacts resulting from the budget process may be stated.

Examples of such impacts are: • Annual budgeting adds little value and takes up too much valuable

management time. • Too heavy a reliance on budgetary control in managing performance has an

adverse impact on management behaviour. • The use of budgeting as a base for communicating corporate goals, setting

objectives, assisting continuous improvement, etc. is seen as contrary to its original purpose as a financial control mechanism.

• Most budgets are not based on a rational causal model of resource consumption and are, therefore, of little use in determining strategy.

• The process has insufficient external focus from which to derive targets or benchmarks. The argument may be put that increased focus on knowledge or intellectual capital through competent managers, skilled workforce, effective systems, loyal customers and strong brands is more likely to yield improved business effectiveness.

(Note: this answer is more detailed than that expected from the average student. An awareness of the problem and debate would suffice.)

MARKING GUIDE

Marks

(a) Benefits of budgeting. Award marks on merit (4 × 2 marks) 8 (b) 2 marks per valid point made, to a maximum of 6 (c) Problems caused by annual budgeting 2 points per valid

point to a maximum of

6 __ Total 20 __ Marks should be awarded on merit for other valid points made.


Documents

P5 - Interim