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Performance Management Paper F5 Course Notes ACF5CN07(D) l F5 Performance Management Study Programme Page Introduction to the paper and the course............................................................................................................... (ii) 1 2a 2b 2c 2d 2e Costing ........................................................................................................................................................ 1.1 Activity based costing................................................................................................................................ 2a.1 Target costing............................................................................................................................................ 2b.1 Life cycle costing ........................................................................................................................................2c.1 Backflush accounting................................................................................................................................. 2d.1 Throughput accounting.............................................................................................................................. 2e.1 End of Day 1 – refer to Course Companion for 3 4 5 6 Home Study Progress test 1 Limiting factor analysis ................................................................................................................................ 3.1 Pricing decisions ......................................................................................................................................... 4.1 Short term decisions.................................................................................................................................... 5.1 Risk and uncertainty.................................................................................................................................... 6.1 End of Day 2 – refer to Course Companion for Home Study Progress test 2 Course exam 1 7 8 9a 9b 10 11a Objectives of budgetary control ................................................................................................................... 7.1 Budgetary systems...................................................................................................................................... 8.1 Quantitative analysis in budgeting............................................................................................................. 9a.1 Learning curves......................................................................................................................................... 9b.1 Budgeting and standard costing ................................................................................................................ 10.1 Variance analysis .................................................................................................................................... 11a.1 End of Day 3 – refer to Course Companion for 11b 12 13 14 15 Home Study Progress test 3 Further variance analysis ........................................................................................................................ 11b.1 Behavioural aspects of standard costing................................................................................................... 12.1 Performance management........................................................................................................................ 13.1 Divisional performance measures ............................................................................................................. 14.1 Further performance management............................................................................................................ 15.1 End of Day 4 – refer to Course Companion for Home Study Progress test 4 Course exam 2 16 17 18 19 20 Answers to lecture examples..................................................................................................................... 16.1 Question and Answer bank ....................................................................................................................... 17.1 Appendix A: Pilot Paper questions ........................................................................................................... 18.1 Appendix B: Relevant articles.................................................................................................................... 19.1 Appendix C: Mathematical formulae.......................................................................................................... 20.1 Don’t forget to plan your revision phase! • • • • Revision of syllabus Testing of knowledge Question practice Exam technique practice BPP provides revision courses, question days, mock days and specific material to assist you in this important phase of your studies. (i) INTRODUCTION Introduction to Paper F5 Performance Management Overall aim of the syllabus To develop knowledge and skills in the application of management accounting techniques to quantitative and qualitative information for planning, decision-making, performance evaluation, and control. The syllabus The broad syllabus headings are: A B C D E Specialist cost and management accounting techniques Decision making techniques Budgeting Standard costing and variance analysis Performance Measurement and control Main capabilities On successful completion of this paper, candidates should be able to: • Explain, apply, and evaluate cost accounting techniques • Select and appropriately apply decision-making techniques to evaluate business choices and promote efficient and effective use of scarce business resources, appreciating the risks and uncertainty inherent in business and controlling those risks • Apply budgeting techniques and evaluate alternative methods of budgeting, planning and control • Use standard costing systems to measure and control business performance and to identify remedial action • Assess the performance of a business from both a financial and non-financial viewpoint, appreciating the problems of controlling divisionalised businesses and the importance of allowing for external aspects. Links with other papers Advanced Performance Management (P5) Performance Management (F5) Management Accounting (F2) (ii) INTRODUCTION F5 is the middle paper in the management accounting section of the qualification structure. It builds upon F2 which covers techniques and feeds into P5 which requires you to think strategically and consider environmental factors. F5 requires you to be able to apply techniques and think about their impact on the organisation. It seeks to examine candidates’ understanding of how to manage the performance of a business. Assessment methods and format of the exam Examiner: Geoff Cordwell The examination is a three hour paper with 15 minutes' reading time. Format of the Exam 4 compulsory 25-mark questions Questions on each paper will be drawn from as many of the five syllabus areas as possible. It is likely that they will be based on simple, realistic scenarios. The paper will be approximately 50% calculation, 50% discussion, but it is unlikely that a fully written question will be set. Wherever possible students will first be asked to analyse / interpret given numbers and then prepare calculations of their own. (iii) INTRODUCTION Course Aims Achieving ACCA's Study Guide Outcomes Amended to reflect presentation in main body A Specialist cost and management accounting techniques A1 A2 A3 A4 A5 Activity based costing Target costing Life cycle costing Backflush accounting Throughput accounting B Decision-making techniques B1 B2 B3 B4 Multi-limiting factors and the use of linear programming and shadow pricing Pricing decisions Make-or-buy and other short-term decisions Dealing with risk and uncertainty in decision-making C Budgeting C1 C2 C3 C4 C5 Objectives Budgetary systems Types of budget Quantitative analysis in budgeting Behavioural aspects of budgeting D Standard costing and variance analysis D1 D2 D3 D4 D5 Budgeting and standard costing Basic variances and operating statements Material mix and yield variances Planning and operational variances Behavioural aspects of standard costing E Performance measurement and control E1 E2 E3 E4 The scope of performance measurement Divisional performance and transfer pricing Performance analysis in not-for-profit organisations and the public sector External considerations and behavioural aspects Chapter 2a Chapter 2b Chapter 2c Chapter 2d Chapter 2e Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapters 7 & 8 Chapter 8 Chapters 9a & b Chapter 7 Chapter 10 Chapter 11a Chapter 11b Chapter 11b Chapter 12 (iv) Chapter 13 Chapter 14 Chapter 15 Chapter 15 INTRODUCTION Classroom tuition and Home study Your studies for BPP consist of two elements, classroom tuition and home study. Classroom tuition In class we aim to cover the key areas of the syllabus. To ensure examination success you will to spend private study time reinforcing your classroom course with question practice and reviewing areas of the Course Notes and Study Text. Home study To support you with your private study BPP provides you with a Course Companion which helps you to work at home and aims to ensure your private study time is effectively used. The Course Companion includes a Home Study section which breaks down your home study by days, one to be covered at the end of each day of the course. You will find clear guidance as to the time to spend on various activities and their importance. You are also provided with progress tests and two course exams which should be submitted for marking as they become due. These may include questions on topics covered in class and home study. BPP Learn Online Come and visit the BPP Learn Online free at www.bpp.com/acca/learnonline for exam tips, FAQs and syllabus health check. ACCA Forum We have thriving ACCA bulletin boards at www.bpp.com/accaforum. Register and discuss your studies with tutors and students. Helpline If you have any queries during your private study simply contact your class tutor on the telephone number or e-mail address that they will supply. Alternatively, call +44 (0)20 8740 2222 (or your local training centre if outside the London area) and ask for a tutor for this paper to speak to you or to call you back within 24 hours. Feedback The success of BPP’s courses has been built on what you, the students tell us. At the end of the course for each subject, you will be given a feedback form to complete and return. If you have any issues or ideas before you are given the form to complete, please raise them with the course tutor or relevant head of centre. If this is not possible, please email [email protected]. (v) INTRODUCTION Key to Icons Exam alert This is an area that commonly gets examined so you should make sure you are comfortable with this section. Formula to learn This formula will not be provided in the exam so you need to learn it. Question practice from the Course Companion Question practice is key to passing the exam. Please refer to your Course Companion Skills test standard A area which has frequently been tested in skills tests Course Companion reference Further reading is needed in this area to consolidate your knowledge (vi) Costing Syllabus Guide Detailed Outcomes Having studied this chapter you will be able to: • Gain a broader background knowledge of areas covered in paper F2. These topics will be built upon throughout F5 Exam Context These topics will not be examined in their own right. However, this knowledge could be examined as part of other topics such as ABC, pricing, etc. Qualification Context You will have studied these areas in F2 and will continue to build on them in your management accounting studies. Business Context Absorption costing is a method of apportioning all the production costs to a unit. Historically, this was a very common costing method in the manufacturing industry. 1.1 1: COSTING Overview Costing Absorption Costing Marginal Costing OAR Contribution Under / Over Absorption Reconciliation of profit 1.2 1: COSTING 1 Principles of absorption costing 1.1 A method whereby all production costs are included in the costing of a cost unit, ie. direct materials, direct labour, variable production overheads and fixed production overheads. IAS2 requires an element of fixed production overhead to be ‘absorbed’ into product cost for inventory valuation purposes. All production costs are charged to units of production. Example of a standard cost card for a cost unit 1.2 $/unit Direct costs: Direct materials Direct labour (5kg @ $3/kg) (3 hrs @ $6/hr) Indirect costs: Variable overheads Fixed overheads Full product cost 2 15.00 18.00 33.00 2.00 3.00 38.00 Calculating the cost per unit 2.1 1.3 1: COSTING Revision Example: CD Factory CD 50c Overheads ??? Royalties $1 Cost Card Box 50c Direct materials: $ 0.50 0.50 3.00 1.00 5.00 ? ? Blank CD Box Direct labour Direct expense: Royalties PRIME (direct) COST Indirect production costs TOTAL PRODUCTION COST Labour ½ hr @ $6/hr Indirect Production costs/ overheads Costs such as rent, supervisor’s salary, electricity etc are also incurred during production but they cannot be directly related to each CD. How should these costs be allocated to a CD? Three Step Process: (1) (2) (3) Allocate/apportion overheads to cost centres Re-apportion service centre costs to production cost centres Absorb into production For example: Total overheads are $20,000 (1) Allocate: Pressing & packing supervisors and a chef. Apportion: Rent based on floor space $10,000 across 1,000m2 (2) Pressing $5,000 Packing $3,000 Canteen $2,000 500m2 $5,000 300m2 $3,000 200m2 $2,000 Re-apportion: Direct method Step Method Reciprocal : no inter-service cost centre work : recognise significant inter-service cost centre work : recognise all inter-service cost centre work Eg. Direct method Total production overheads Split canteen based on no. employees (80% pressing, 20% packing) (3) Absorb into production 1.4 Total $ 20,000 Pressing $ 10,000 Packing $ 6,000 Canteen $ 4,000 20,000 3,200 13,200 800 6,800 (4,000) Nil 1: COSTING 3 Overhead absorption rates 3.1 O.A.R = Estimated overhead costs Expected (normal) activity level Example CD Factory continued. (Step 3) Absorb into production – Produce 20,000 CDs Pressing = $13,200/20,000 CDs = Packing = $6,800/20,000 CDs = $0.66 $0.34 $1.00 → add to cost card Absorption Costing Summary 3.2 PRODUCTION COSTS DIRECT COSTS $5.00 per unit INDIRECT COST 1 Allocate + apportion: Pressing $10,000 Packing $6,000 2 Re-allocate service CCs: Pressing $13,200 Packing $6,800 2 Absorb into production Pressing $0.66 Packing $0.34 Canteen $4,000 COST CARD $ 1.00 3.00 1.00 5.00 1.00 6.00 Direct materials Direct labour Direct expenses PRIME COST Fixed overheads absorbed TOTAL PRODUCTION COST 1.5 1: COSTING 4 Absorption into units of production Bases 4.1 (a) (b) (c) (d) (e) (f) Per unit Per direct labour hour Most frequently used in exams Per machine hour Percentage of direct materials cost Percentage of direct labour cost Percentage of prime cost 4.2 The basis level is always determined by the normal level of activity (IAS2) and the basis chosen should bear some reasonable relationship to the product. Example CD Factory continued. If the factory produces CDs and DVDs, it cannot absorb $1 per unit across both. Labour hours are as follows: DVD CD Pressing 1 hr ½ hr Packing ¼ hr ¼ hr Pressing 10,000 labour hours 5,000 labour hours 15,000 labour hours Produce 10,000 DVDs Produce 10,000 CDs Packing 2,500 labour hours 2,500 labour hours 5,000 labour hours OAR Pressing = $13,200 / 15,000 labour hours = $0.88/hr Packing = $6,800 / 5,000 labour hours = $1.36/hr ∴ DVD OAR: Pressing Packing $ 0.88 0.34 1.22 (1hr x $0.88) (¼ hr x $1.36) ∴ CD OAR: Pressing Packing (1/2 hr x $0.88) (¼ hr x $1.36) 1.6 0.44 0.34 0.78 1: COSTING 5 Under / Over Absorption 5.1 $ X (X) X/(X) Actual overhead expenditure Amount of overhead absorbed Under/(over) absorption 5.2 Reasons for under/over absorption: Expenditure variance – Actual overhead expenditure differed from budgeted overhead expenditure. Volume variance – Actual production activity differed from expected (normal) activity level. Lecture example 1 Preparation question Selling price per unit Variable costs per unit direct materials direct labour production overhead selling and distribution Fixed costs: Production: budgeted actual Selling and distribution: (budgeted and actual) $10 $2 $3 $1 $1 $8,000 $8,500 $2,000 Activity levels: Year 1 Units 4,000 4,200 4,400 Budgeted production Actual sales Actual production There is no opening inventory in Year 1. Required Prepare an income statement under absorption costing. 1.7 1: COSTING Solution Year 1 $ Sales Cost of sales: opening inventory Production: variable costs fixed costs closing inventory (Over)/under absorption Gross profit Variable selling & distribution Fixed selling & distribution Net profit Workings: 1.8 $ 1: COSTING 6 Advantages and disadvantages of absorption costing 6.1 Advantages of absorption costing. 6.2 (a) It recognises that selling prices must cover all costs. (b) It complies with IAS 2 on accounting for inventory, whereby the value of inventory must include an appropriate amount of fixed production overhead. Disadvantages of absorption costing. (a) Profits can be manipulated by simply changing production levels. This is because overheads will be carried forward in closing inventory. (b) It is based on the assumption that overheads are volume related. In the next chapter we will see that ABC assumes that many overheads are complexity and diversity related, not merely volume related. 7 Principles of marginal costing (variable costing) 7.1 (a) A principle whereby variable production costs only are charged to cost units and the fixed costs attributable to the relevant period are written off in full against the contribution for the period. (b) Inventory is valued at variable cost of production. 8 Contribution 8.1 Contribution towards fixed costs is represented by: (a) Selling price per unit less all variable costs per unit (whether production admin. or selling etc). (b) Fixed costs + profit. 1.9 1: COSTING Lecture example 2 Preparation question There is no opening inventory in Year 1. Selling price per unit Variable costs per unit direct materials direct labour production overhead selling and distribution Fixed costs: Production: budgeted actual Selling and distribution: (budgeted and actual) $10 $2 $3 $1 $1 $8,000 $8,500 $2,000 Activity levels: Units 4,000 4,200 4,400 Budgeted production Actual sales Actual production Required Complete the income statement under marginal costing principles. Solution $ Sales Variable production costs: opening inventory production closing inventory Variable selling & distribution CONTRIBUTION Fixed costs: production selling & distribution PROFIT 1.10 $ 1: COSTING Workings: 9 Advantages and disadvantages of marginal costing Advantages 9.1 (a) Most appropriate for decision making as it highlights contribution. (It is useful for short-term pricing decisions or decisions on one-off or ad-hoc contracts.) (b) Fixed costs are treated in accordance with their nature, ie as period costs. (c) Profit depends on sales and efficiency not on production levels. (d) Slightly simpler variance analysis. Disadvantages 9.2 (a) There is a danger that products will be sold on an ongoing basis at a marginal contribution which fails to cover fixed costs. (b) Does not comply with IAS 2, thus necessitating year end adjustments for the preparation of published accounts. (c) Necessitates analysis of mixed costs between fixed and variable. (d) Seasonal variations in a year can cause unnecessary profit variances. 1.11 1: COSTING 10 Effect of inventory valuation on profit 10.1 (a) Production = sales (so inventory is constant) AC profit = MC profit (b) Production < sales (so inventory is falling) AC profit < MC profit (c) Production > sales (so inventory is climbing) AC profit > MC profit 10.2 If there is a difference between the two profit figures the difference between the figures will effectively be the OAR/unit x movement in inventory. 10.3 You can remember which profit will be highest using SIAM S – I – A – M– Stock (Inventories) Increase Absorption profit More Lecture example 3 Preparation question Reconcile the profit figures calculated in lecture examples 1 and 2. Solution 1.12