performance-management

Performance Management | Page 1 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

TABLE OF CONTENTS Note: click the cross-reference below for easy navigation. Click + Home to come back.

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TABLE OF CONTENTS ........................................................................................................... 1 KEY TERMS ................................................................................................................................ 3 AUTHOR’S PROFILE ............................................................................................................... 6 IMPORTANT!............................................................................................................................. 7 Chapter 1: ACTIVITY BASED COSTING .......................................................................... 9 Chapter 2: LIFE CYCLE COSTING ................................................................................... 37 Chapter 3: TARGET COSTING .......................................................................................... 42 Chapter 4: THROUGHPUT ACCOUNTING ................................................................... 49 Chapter 5: ENVIRONMENTAL ACCOUNTING ........................................................... 58 Chapter 6: RELEVANT COSTING .................................................................................... 60 Chapter 7: SHORT-TERM DECISION-MAKING ......................................................... 64 Chapter 8: COST VOLUME PROFIT ANALYSIS.......................................................... 67 Chapter 9: PRICING DECISIONS...................................................................................... 69 Chapter 10: LINEAR PROGRAMING .............................................................................. 72 Chapter 11: RISK & UNCERTAINTY IN DECISION-MAKING ............................... 74 Chapter 12: LEARNING CURVE THEORY .................................................................... 76 Chapter 13: FORECASTING............................................................................................... 78 Chapter 14: BUDGETING SYSTEMS............................................................................... 81 Chapter 15: TYPES OF BUDGETING .............................................................................. 83 Chapter 16: BASIC VARIANCE ANALYSIS ................................................................... 85 Chapter 17: MIX & YIELD VARIANCES ........................................................................ 88 Chapter 18: PLANNING & OPERATIONAL VARIANCE .......................................... 90 Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT ................................ 92 Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT ..................... 96 Chapter 21: TRANSFER PRICING ................................................................................ 100 Buy Full Performance Management Book (375±) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 2 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

Chapter 22: BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT .................................................................................................................................................... 103 RELATED eBOOKS ............................................................................................................. 105 REPORT ABUSE .................................................................................................................. 106 Performance MANAGEMENT EBook Free Download

Special Offer Place a http://accasupport.com link at any ONE of your or other account to get any TWO chapters above of your choice for free not included in free version by emailing at kabuli_52@hotmail.com or murtaza@accasupport.com Email should contain web page URL where you have placed a link and name of any TWO chapters you want.

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Performance Management | Page 3 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

KEY TERMS Direct Labour Budget · 119 Dividend Cover · 129 Dividends Yield · 129

A Absorption Costing · 40 Acid Test Ratio · 129 Additive Model · 114

E Earnings per Share (EPS) · 129 Earnings Yield · 129 Economy · 133 Effectiveness · 133 Efficiency · 133 Efficiency Ratio · 133 Equity · 132

B Benchmarking · 133 Blanket Rate or Single Factory Wide Rate · 41 C Capacity Ratio · 133 Cash Budgets · 119 Clear · 132 Coefficient of Correlation · 114 Coefficient of Determination · 114 Competitive Performance · 133 Consumer Price Index (CPI) · 114 Contribution · 47 Controllability · 132 Critical Success Factors (CSF) · 132 Current Asset Ratio · 129 Cyclical Variations · 114

F Financial Gearing · 129 Financial Performance · 133 Fixed Production Overhead Capacity Variance · 121 Fixed Production Overhead Variance · 121 Flexibility · 133 Functional Budgets · 119 G Gross Profit Margin · 128

D

I

Departmental Overhead Absorption Rate · 42 Deseasonalisation · 115 Determinants · 132 Dimensions · 132

Innovation · 133 Interest Cover · 129 Inventory Turnover · 129

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Performance Management | Page 4 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

K

Q

Key Performance Indicators (KPI) · 132

Quality · 132 Quick Ratio · 129

L

R

Labour Cost Variance · 121

Random Variations · 114 Raw Materials Budget · 119 Regression Analysis · 114 Residual Income (RI) · 130 Resource Utilization · 133 Results · 133 Retail Price Index (RPI) · 114 Return on Capital Employed (ROCE) · 129 Return on Equity (ROE) · 130 Return on Investment (ROI) · 129 Rewards · 132

M Marginal Costing · 47 Master Budgets · 119 Material Cost Variance · 121 Motivation · 132 Multiplicative Model · 115 O Operating Profit Margin · 128 Operational Gearing · 129 Overhead Budget · 119 Ownership · 132

S Sales Budget · 119 Seasonal Variations · 114 Share Options · 139 Standards · 132

P Payout Ratio · 129 Pre-determined Overhead Absorption Rate · 40 Pre-Determined Overhead Absorption Rate · 40 Price Earnings (P/E) Ratio · 129 Principle Budget Factor · 119 Production Budget · 119 Production Volume Ratio · 133

T Trade Payable Turnover · 129 Trade Receivable Turnover · 129 Trend · 114 V Value for Money · 133

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Performance Management | Page 5 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

Variable Production Overhead

Variance 路 121

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Performance Management | Page 6 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

AUTHOR’S PROFILE Name: Murtaza Lanewala.

Career Status: Freelance writer & tutor for professional accountancy qualifications. Professional bodies include ACCA, CIMA and ICAEW. Author & CEO of accasupport.com E-mail: kabuli_52@hotmail.com or murtaza@accasupport.com

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Performance Management | Page 7 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

IMPORTANT! 1 Disclaimer This material is sold only through accasupport.com website. However, Clickbank.com is the credit card processing organization for collecting payments for this material. This material is not available offline (shops, schools etc.) in any form such as DVDs, CDs, Printed books etc. Materials purchased from unauthorized source can be out of date and incomplete. In addition, you will not be able to receive free updates given to the buyers of original material.

Demo version of this material is available free of cost, please take care, not to pay for demo version of this e-book to unauthorized sellers.

Readers of this material will be solely responsible for the consequences of any decisions made in real life. Author & accasupport.com are not responsible to the readers of this material under any circumstances.

Recommendations made of any kind are intelligent guesses to the best of author’s knowledge.

Names of individuals, organizations, countries, religions etc are used for educational purpose only. It is not intended to abuse, discriminate and heart anyone's feelings and dignity.

2 Copyright Notice This material is subject to copyright protection law. Infringement of copyright law results in criminal liability (fine or imprisonment or both).

Copyright infringement is effectively theft of intellectual property; therefore, it is unethical from social viewpoint and sinful act from religious viewpoint as well.

Copyright ©2012 Murtaza Lanewala. All rights reserved.

2.1 Do You can make a backup copy of this material.

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Performance Management | Page 8 of 106 THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM

You can use parts of this material provided you quote the appropriate reference to the author and material.

2.2 Do Not You cannot publicly share this material in the form of hard copy or soft copy (physically and over the internet) for cash or for free.

You cannot transform this material into other means of communication such as photocopy, video, audio etc. Unless needed for accessibility purpose or personal use.

You cannot change the file format of this material or make it editable.

You cannot resell this material unless you are selling the original copy purchased.

You cannot use any part of this material in or with contents associated with violence, politics, religious and pornographic contents in any way.

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Performance Management | Page 9 of 106 Chapter 1: ACTIVITY BASED COSTING

Chapter 1:

ACTIVITY BASED COSTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Absorption Costing 2 Pre-Determined Overhead Absorption Rate 3 Calculating Products Cost Using Absorption Costing 4 Marginal Costing 5 Contribution 6 Activity Based Costing 7 Commenting On Results under ABC & Absorption Costing 8 Implications for Pricing & Profitability 9 Increasing Popularity of ABC 10 Benefits & Limitations of ABC 11 ABC Vs Absorption Costing Vs Marginal Costing 12 Practice Question & Solution

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Performance Management | Page 10 of 106 Chapter 1: ACTIVITY BASED COSTING

1 Absorption Costing Absorption costing is the traditional technique for recovering (absorbing) overheads (indirect costs) via including it in products cost on some fair basis.

It is due to overhead costs, which form, significant part of the product cost cannot be identified directly and allocated, like direct material & direct Labour.

Need for absorbing overhead arises when organization manufactures more than one type of product. Each product may consume different amount resources and therefore consumes different amount of overhead cost.

In service industries, absorption costing is used to absorb overheads cost incurred into services provided.

In retail organizations, there are no or little overheads, such as packaging and labelling. These overhead costs are unlikely to be significant and therefore, cost incurred in absorbing overhead cost into products may not exceed revenue. Therefore, overheads are treated as period cost rather than included into product cost.

2 Pre-Determined Overhead Absorption Rate Pre-determined overhead absorption rate is calculated on budgeted amount and budgeted activity level. It is calculated at the beginning of the period before actual overhead costs are incurred in manufacturing products.

This allows including share of overheads in the product cost and setting selling price in advance.

2.1 Blanket Rate or Single Factory Wide Rate Formula:

It is used were organization have single department or multiple departments having similar kind of activities (labour intensive or machine intensive), which each department performs for manufacturing good or providing services.

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Performance Management | Page 11 of 106 Chapter 1: ACTIVITY BASED COSTING

A laundry shop, where cloths are washed and dried using washing machines.

An organization selling handmade biscuits, in which every work from making dough to rolling and cooking are all Labour intensive operations.

2.1.1 Calculating Blanket Rate Formula:

Illustration: Organization has following detail for overhead cost in the upcoming period.

Expenses $ Factory rent 50,000 Power cost 15,000 Machine & tools depreciation 10,000 Machine maintenance cost 6,000 Cleaning & hygiene 4,000 Subsidized canteen 5,000 Total allocated overheads 328,000 Total reapportioned overheads 418,000

Machine hours Labour hours

Production cost centres Cutting Assembling Finishing 8,000 4,000 3,200 5,000 8,000 5,000

Service cost centres Cleaning Canteen 2,000 1,000 1000 1000

Total 18,200 20,000

Organization wishes to absorb overheads on machine hour basis.

Required: Calculate factory wide absorption overhead rate.

Solution:

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Performance Management | Page 12 of 106 Chapter 1: ACTIVITY BASED COSTING

2.2 Departmental Overhead Absorption Rate Department overhead absorption rate is the rate used for each department specifically based on kind of activities (manual or automated) it performs for manufacturing goods or providing services.

Example: A clothes manufacturing company, where yarns of cloth are manufactured using machines; and cutting and sewing is done manually by Labours.

2.2.1 Calculating Departmental Overhead Absorption Rates Calculation of departmental overheads requires allocation and apportionment of overheads.

Formula:

Illustration: Organization has following detail for overhead cost in the upcoming period.

Expenses Factory rent Power cost Machine & tools depreciation Machine maintenance cost Cleaning & hygiene Subsidized canteen

Total allocated overheads Machine hours Floor area Factory volume No of Labours (direct & indirect) Labour hours

$ 50,000 15,000 10,000 6,000 4,000 5,000

Production cost centres Service cost centres Cutting Assembling Finishing Cleaning Canteen Total $106,000 $108,000 $114,000 $328,000 8,000 4,000 3,200 2,000 1,000 18,200 5,000 5,000 5,000 500 2,000 17,500 8,000 8,000 8,000 800 1,000 25,800 30 5,000

30 8,000

30 5,000

5 1000

5 1000

100 20,000

Organization wishes to absorb overheads on machine hour basis for cutting cost centre and on labour hour basis for assembling and finishing cost centre.

Required: Calculate departmental overhead absorption rate for each production cost centre.

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Performance Management | Page 13 of 106 Chapter 1: ACTIVITY BASED COSTING

Solution:

Factory rent Power cost Machine & tool depreciation Machine maintenance cost Cleaning and hygiene Subsidized canteen Total overhead costs Cleaning cost Canteen cost Cleaning cost Canteen cost Total allocated overheads

Production cost centres Cutting Assembling Finishing $ $ $ 14,286 14,286 14,286 4,651 4,651 4,651 4,396 2,198 1,758

Service cost centres Cleaning Canteen $ $ 1,429 5,714 465 581 1,099 550

2,637

1,319

1,055

659

0 0 25,970 2,449 28,419 3,941 32,360 210 32,570 8.2 32,578.2

0 0 22,454 2,449 24,903 3,941 28,844 210 29,054 8.2 29,062.2

0 0 21,750 2,449 24,199 3,941 28,140 210 28,350 8.2 28,358.2

4,000 0 7,652 (7,652) 0 657 657 (657) 0 1.37 1.37

106,000 138,578.2

108,000 137,062.2

114,000 142,358.2

1.37

Total $ 50,000 15,000 10,000

330

6,000

5,000 12,175 306 12,481 (12,481) 0 26 26 (26) 0

4,000 5,000 90,000 0 90,000 0 90,000 0 90,000 0 90,000

0

328,000 418,000

Explanation To determine cutting department overheads based on machine hours as cutting department seems to be machine intensive.

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Performance Management | Page 14 of 106 Chapter 1: ACTIVITY BASED COSTING

Explanation To determine assembling department overheads based on Labour hours as assembling department seems to be Labour intensive.

Explanation To determine finishing department overheads based on Labour hours as finishing department seems to be Labour intensive.

2.3 Selection of Basis for Overhead Absorption Rates The following bases for absorption of overheads are usually used but other methods are also possible. Organization may choose any other method as it consider appropriate. These are:  No of units produced.  No of labour hours.  No of machine hours.  Total direct material cost.  Total direct Labour cost.  Prime cost (Direct material + Direct Labour + Direct expenses). It is the sum of all direct costs.  Conversion cost (Direct Labour + Factory Overheads). It is the cost of converting material into finished goods.

3 Calculating Products Cost Using Absorption Costing Diagram: Costs Direct material

Details

$ X

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Performance Management | Page 15 of 106 Chapter 1: ACTIVITY BASED COSTING

Costs Details Direct Labour Direct expense Prime cost Production overheads (Based on absorption rate) Product cost Admin overheads (Period cost) Selling & distribution (Period cost)

$ X X X X X X X X X

Full cost

Illustration: An organization has following data for calculating product cost in upcoming period.

Direct Material

$300,000

Direct Labour

$250,000

Direct Expenses

$100,000

Production overheads are absorbed on basis of factory wide rate of $22.967/machine hour.

There will be 18,200 machine hour (estimated) during the period.

Selling cost for the period is estimated at $5/ unit.

Sales and production volume for the period is 10,000 units and there was no closing inventory in the previous period.

Administration cost for the period is $ 50,000.

Required: Calculate the product cost and product cost per unit and full cost.

Solution: Costs Workings $ Workings $/unit Direct material 300,000 ($300,000/10,000) 30 Direct Labour 250,000 ($250,000/10,000) 25 Direct expense 100,000 ($100,000/10,000) 10 Prime cost 650,000 65 ($22.967 x Production (Budgeted) 418,000 41.80 18,200hrs/10,000units) overheads Product cost 1,068,000 ($1,068,000/10,000) 106.8 Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 16 of 106 Chapter 1: ACTIVITY BASED COSTING

Workings

$ 1,068,000 (Period cost) 50,000 ($5 x 10,000) 50,000

Product cost Admin overheads Selling & distribution Full cost

1,168,000

Administration, Selling and distribution overheads are only included when specifically instructed to do so.

Finance overheads are never included in product cost.

Illustration (Extract 06/10: Q1, a): BBB has a policy to price all jobs at budgeted total cost plus 50% mark up.

Overheads are currently absorbed on labour hour basis.

Total overheads Labour hours $400,000 40,000

Product Materials Labour hours GC $3,500 300 EX $8,000 500

Labour is paid $15 per hour.

Required: Calculate the cost and quoted price of a GC and of an EX using labour hours to absorb the overheads.

Solution: Details Materials Labour Overheads Total cost Quoted price

Workings 300hrs x $15/hr 300hrs x $10/hr (W1) 11,000 x 150%

GC 3,500 4,500 3,000 11,000 16,500

Workings 500hrs x $15/hr 500hrs x $10/hr (W1) 20,500 x 150%

EX 8,000 7,500 5,000 20,500 30,750

Workings:

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Performance Management | Page 17 of 106 Chapter 1: ACTIVITY BASED COSTING

â „

4 Marginal Costing Marginal costing is the technique used to determine product cost and used for other short-term decision-making purpose.

Examples: Whether to manufacture in-house or buy from external supplier.

How much of each product should be manufactured.

Whether to accept or reject offer made by customer or supplier.

Whether to continue or discontinue an operation.

Marginal costing only considers variable costs as relevant for decision-making.

It considers all fixed costs as irrelevant and so it is not taken into account for short-term decision-making.

Marginal costing recognizes fixed costs as irrelevant because in short-term, fixed cost remains constant (unchanged) with change in activity level.

Marginal costing not only considers production costs (Material, Labour and Overheads) as variable; it also considers non-production variable costs (Selling & distribution, administration and finance overheads) as relevant for product costing. Marginal costing leads to all variable costs being considered in decision-making process.

5 Contribution Contribution is figure obtained after deducting all variable costs from sales.

Marginal costing considers only contribution as relevant for decision-making rather than profit.

5.1 Calculating Contribution & Profit in Marginal Costing Formula:

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Performance Management | Page 18 of 106 Chapter 1: ACTIVITY BASED COSTING

$ Sales revenue Variable costs (Product Cost) Direct material Direct Labour Variable production overheads Variable selling & distribution overheads Variable administration overheads Total variable cost Contribution Fixed costs (Period Cost) Fixed production overheads Fixed selling & distribution overheads Fixed administration overheads Total fixed cost Net Profit

$ X (X) (X) (X) (X) (X) (X) X (X) (X) (X) (X) X

Illustration: An organization has sales revenue of $1,000,000 and following costs: Direct materials Direct Labours Variable production overheads (indirect material + indirect Labour) Fixed production overheads Selling & distribution overheads (60% fixed cost) Administration overheads (80% fixed cost) Finance overheads (100% fixed cost)

$(000) 100 150 100 150 150 120 50

Required: Calculate contribution and profit. Comment on the results.

Solution: $(000) Sales revenue Variable costs (Product Cost) Direct materials Direct Labours Variable production overheads Selling & distribution overheads ($150 x 40%) Administration overheads ($120 x 20%) Total variable costs Contribution

$(000) 1,000

100 150 100 60 24 434 566

Fixed costs (Period Cost) Fixed production overheads 150 Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 19 of 106 Chapter 1: ACTIVITY BASED COSTING

Selling & distribution overheads ($150 x 60%) Administration overheads Total fixed cost (excluding finance overheads) Net Profit/Operating Profit

$(000) 90 96

$(000) 336 230

Contribution indicates how each product will contribute towards recovery of fixed cost.

As i said earlier that fixed cost is irrelevant. However, if organization has to survive, then it has to recover its total cost (Variable + Fixed) to break even (no profit/no loss) and earn profits in the long term.

5.2 Uses of Contribution  Contribution is used for decision-making regarding one off opportunity such as bidding for tender.  Contribution indicates impact of management decision on liquidity (cash flows), which is vital for survival of the organization. Variable costs involve cash outflows whereas fixed cost contains both cash as well as non-cash expenses such as depreciation.  Contribution allows determining profit-maximizing combination of selling price and demand.  Contribution allows evaluating proposals such as outsourcing; buying materials from outside supplier; discontinuing activities, products, departments, branches etc.  Contribution helps in determining the optimal production mix. Products can be ranked according to the level of contribution per limiting factor provided by each product.

5.3 Contribution Vs Profit Contribution Contribution is relevant in the short-term.

Contribution is objective indicator of organizational performance.

Profit Profit is relevant in the long-term.

Profit is subjective indicator of organizational performance, as it requires absorption of fixed costs on some fair basis.

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Performance Management | Page 20 of 106 Chapter 1: ACTIVITY BASED COSTING

Contribution Contribution is more useful for management accounting purpose.

Management accountants have to assist managers in their day-to-day decision-making.

Contribution is only useful for shortterm planning and control as it ignores fixed costs.

Contribution can be used fairly as an indicator of cash flow movements.

Profit Profit is more useful for financial accounting purpose so that management can be held accountable for total cost (variable + fixed) incurred.

Profit is useful for long-term planning and control as it takes account of variable as well as fixed costs. In longterm, all fixed costs are considered as variable.

Profit reflects both cash & non-cash income/expenditures such as interest receivable, depreciation respectively.

6 Activity Based Costing ABC is modern costing technique. It is used as an alternative to absorption costing technique.

It also absorbs production, selling, and admin overheads to find full cost of the product(s).

ABC considers all cost (variable + fixed) as variable in the long term.

In addition to product cost, it is also used to determine the cost of activity(s) such as delivering customer order.

6.1 Understanding Key Terms 6.1.1 Activity Activity is the series of tasks performed in harmony for which customers are willing to pay.

Example: Selling goods is an activity. It requires performing individual tasks such as credit rating analysis, raising sales order, dispatching goods etc. Customers are willing to pay for these activities in order to buy goods from the organization.

Without these activities, customers will not be able to buy goods.

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Performance Management | Page 21 of 106 Chapter 1: ACTIVITY BASED COSTING

6.1.2 Cost Driver Cost driver is the reason for performing an activity and therefore, reason for cost associated with activity.

Example: Number of orders received can be a cost driver for selling goods. Sales are made, whenever customer places an order. Increase in number of orders received will lead to increase in selling cost.

6.1.3 Cost Pool Cost pool is the group of all costs related to particular activity.

Example: Selling cost is the cost pool for all cost associated with selling goods such as computer depreciation, computer operator salaries and printing cost etc.

6.2 Steps for Calculating Product Cost under ABC 6.2.1 Step1 Identify cost driver (one or more) for each cost pool.

Example: Number of deliveries for delivery cost.

6.2.2 Step2 Apportion cost pools in the ratio of total number of activity performed by each cost driver.

Example: Delivery cost by number of long distance deliveries (60%) and number of short distance deliveries (40%). Hence, apportionment of delivery cost will take place in the ratio of 6:4

6.2.3 Step3 Determine ABC absorption rate by dividing cost pool with total number of activity performed by respective cost driver.

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Performance Management | Page 22 of 106 Chapter 1: ACTIVITY BASED COSTING

Formula:

Example: Long distance delivery cost with number of long distance deliveries.

Short distance delivery cost with number of short distance deliveries.

6.2.4 Step4 Absorb (allocate) overhead cost using ABC absorption rate to products.

Multiply the ABC absorption rate with total number of activity consumed by each product.

Formula:

Example: Product A has consumed 400 long distance deliveries and 1,000 short distance deliveries.

Product B has consumed 500 long distance deliveries and 400 short distance deliveries.

6.2.5 Step5 Total all the allocated overhead costs for each product and also add direct material and direct labour cost to determine full cost of product.

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Performance Management | Page 23 of 106 Chapter 1: ACTIVITY BASED COSTING

To determine unit cost of a product by dividing full product cost with total activity level of a product.

Activity level can be either production volume or sales volume. Production volume should be used when costing for product or production related activities. Sales volume should be used when costing for sales related activity such as customer order deliveries.

To determine selling price add mark-up percentage. Mark-up percentage will be given in the question.

Example: Organization wishes to earn 20% profit margin on a product.

If you are given profit margin, then covert margin into mark-up, using following formula: Formula:

6.3 Calculating Product Costing Using ABC Illustration: Brick by Brick (BBB) is a building business that provides a range of building services to the public. Recently they have been asked to quote for garage conversions (GC) and extensions to properties (DC) and have found that they are winning fewer GC contracts than expected.

BBB has a policy to price all jobs at budgeted total cost plus 50%. Overheads are currently absorbed on a labour hour basis. BBB thinks that a switch to activity based costing (ABC) to absorb overheads would reduce the cost associated to GC and hence make them more competitive.

You are provided with the following data: Annual overheads Overhead category $ Supervisors 90,000 Planners 70,000 Property related 240,000

Activity driver Site visits Planning documents Labour hours

Total number of activities per year 500 250 40,000

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Performance Management | Page 24 of 106 Chapter 1: ACTIVITY BASED COSTING

Annual overheads Overhead category $ Total 400,000

Total number of activities per year

Activity driver

A typical GC costs $3,500 in materials and takes 300 labour hours to complete.

A GC requires only one site visit by a supervisor and needs only one planning document to be raised. The typical DC costs $8,000 in materials and takes 500 hours to complete. An EX requires six site visits and five planning documents.

In all cases, labour is paid $15 per hour.

Required: Calculate the cost and the quoted price of a GC and of an EX using ABC to absorb the overheads.

Solution: Quoted Price Using ABC Workings Materials Labour

(300 x $15/hr) (500 x $15/hr)

Overheads (step3) Supervisor Planners Property Full Cost Mark up 50% on cost Quoted Price

GC $ 3,500 4,500

EX $ 8,000 7,500

180 280 1,800 10,260 5,130 15,390

1,080 1,400 3,000 20,980 10,490 31,470

Workings: Step1 (optional) Cost Pool Cost Driver Supervisors Site visits Planners Property related

Reason Monitoring sites incurred supervisors cost Planning documents incurred planners cost Labours are used to complete property contracts.

Planning documents Labour hours

Step2 In this question, there is one cost driver for each cost pool, so there no need for cost pool apportionment.

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Performance Management | Page 25 of 106 Chapter 1: ACTIVITY BASED COSTING

Step3 Cost pool Annual overheads in $ á Total number of activities ABC absorption rate Supervisors 90,000 500 180 Planners 70,000 250 280 Property related 240,000 40,000 6

Step4 Cost Pool Activities consumed Supervisors 1:6 Planners 1:5 Property related 6:6

GC (1 x 180)180 280 1,800

EX (6 x 180)1,080 1,400 3,000

7 Commenting On Results under ABC & Absorption Costing Absorption costing allocates more overheads to high volume (labour, machine hours) products and allocates lesser overheads to low volume products.

Example: If product A consumes 400 labour hours and product B consumes 800 labour hours then product B will consume double overheads than product A. Allocation of overheads based on volume not may be representative of the way in which actual overheads are incurred by each product.

Example: Product A (low volume) may be produced in smaller batches than product B (high volume). Smaller batches will incur more setup cost than larger batches.

Machines may have to be frequently organized in different way and needs to be adjusted. This will result in increased idle time cost for labour.

Therefore, product A will incur more setup cost than product B. Absorption costing does not take account of this fact.

Activity based costing allocates more overheads to product consuming more activities (setup, material handling etc) and allocates lesser overheads to products consuming less activities.

Example: If product A consumes 6 setups and product B consumes 3 setups, then product A will consume double overheads than product B. Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 26 of 106 Chapter 1: ACTIVITY BASED COSTING

Some products may require more setups because of production in smaller and more frequent batches. These may be slow moving products or products of perishable nature, which will become obsolete if stored for longer time.

Conversely, some products may require fewer setups because of production in larger batches. These may be fast moving products or products having unpredictable demand, which needs to be stored to meet unexpected demand.

Activity based costing differentiates cost drivers between activity based cost drivers and volume based cost drivers.

Activity based cost drivers change with changes in number of activities (setup, invoicing, deliveries etc).

Volume based cost drivers change with changes in volume (labour or machine hours, units etc). Some overhead costs are still change with volume such as machine depreciation.

Activity based costing takes account of the fact that it is number of activities which incurs majority of the costs rather volume (labour or machine hours) of the product.

In today’s manufacturing environment, responsiveness to customer is considered as the key to success. It gives rise to number of supporting activities and related costs. It makes activity-based cost drivers significant part of overheads cost rather than volume based cost drivers.

Activity based costing closely allocates each type of overhead cost to respective activities which incur cost rather than allocating all types of overhead costs on single factory wide or departmental overhead rate (labour or machine hours). Therefore, ABC costing makes use of greater number of overhead absorption rates rather than two or three overhead absorption rates used in absorption costing.

Activity based costing gives fairer reflection of actual overheads incurred by each product.

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Performance Management | Page 27 of 106 Chapter 1: ACTIVITY BASED COSTING

8 Implications for Pricing & Profitability Activity based costing enable more accurate pricing of products. Products consuming more activities and cost can be charged higher to customers.

Products consuming fewer activities and cost can be charged fairly to customers.

Absorption costing allocates lesser overhead cost to low volume products and more overhead cost to high volume products. Mark up % on less costly product results in lower selling and more costly product results in higher selling price.

Absorption costing results in under-pricing of low volume and high activity products and over pricing of high volume and low activity products.

Example: Product A (low volume & high activity product) will be under-priced which would otherwise be priced using ABC. Product B (high volume & low activity product) will be over priced which would otherwise be priced using ABC. Under priced products will probably result in lower selling price than market price provided competitors allocating cost to their products using ABC. Therefore, profitability of low volume and high activity product will suffer due to not having sufficient gross profit margin. Eventually, organization will decide to discontinue that product which is actually profitable. This will result in dysfunctional decision-making.

Over priced products will probably result in higher selling price than market price. Therefore, this will result in high gross profit margin. However, profitability of high volume and low activity product will suffer due to not having sufficient sales demand. Organization will be motivated to produce more units of that product because of higher gross profit margin.

Activity based costing can be used to prevent this problem. Benefits of switching to ABC need to be evaluated against the cost of implementing and maintaining ABC.

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Performance Management | Page 28 of 106 Chapter 1: ACTIVITY BASED COSTING

9 Increasing Popularity of ABC Information technology has reduced information management cost, making ABC feasible to implement and operate.

Focus shift from product to customer resulting in smaller production runs (batches) and increased production setup cost (overheads).

Just in time inventory management philosophy resulting in increased inventory ordering cost (overheads), as inventory is purchase or produced only when demanded by customer.

Shorter product life due to rapidly changing technology resulting in increased marketing and development expenditure (overheads).

Internet leading to increased customer awareness on prices creating a need for more competitive product pricing to achieve advantage over competitors.

Government legislation being stricter regarding customer protection to prevent violation of customer rights. This will result in more inspection and material handling overhead costs.

10 Benefits & Limitations of ABC 10.1 Benefits  ABC gives more accurate product cost.  ABC gives full cost of product as it includes selling and admin overheads in addition to production overheads.  ABC gives long-term product cost as it recognizes all the cost as variable, changing with changing activity levels.  ABC is realistic approach to product costing.  ABC encourages long-term decision-making approach by managers. Thus, avoiding adverse impact of short-term decision making on long-term growth and stability.  Cost of sales and inventory value calculated based on ABC can be used for financial reporting purpose. ABC gives full product cost and provides Buy Full Performance Management Book (375±) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 29 of 106 Chapter 1: ACTIVITY BASED COSTING

accurate information on financial performance and position of the organization.  It recognize that difference between volume based cost drivers (for cost which increases with volume such as machine maintenance cost) and transaction based cost drivers (for cost which increases with transactions such as delivery cost)  ABC directs relates costs to the reasons for incurring costs in the form of cost drivers. Costs are incurred due to activities in any organization rather than number of departments.  Due to extensive information on activities is available, ABC costing can form the basis of ABC budgeting. This resulting in more realistic budgeting.  It gives information for cost control and reduction purpose.

Example: Information that production in larger batches will decrease production setup costs.

10.2 Limitations  ABC is expensive to implement and operate because of such detailed information is needed on cost drivers and cost pools.  Organization may not have sufficient resources and time to implement ABC.  Managers may not understand the importance of ABC costing information for product costing and pricing purpose as it is too technical.  ABC information gathering process can consume a lot of managerial time in meeting and discussion, which can be used elsewhere to generate revenues. However, information technology has greatly reduced information-management costs. Thus, ABC is getting more affordable.  It may not deliver same benefits to smaller organization who have few activities, similar production processes and few products as compared to larger organization having many activities, complex production process and too many products.

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Performance Management | Page 30 of 106 Chapter 1: ACTIVITY BASED COSTING

ďƒ Cost of implementing an ABC might not exceed benefits obtained from getting more accurate information.

Hence, benefits of ABC costing are more than its limitations. That is why; ABC is increasingly being adopted by many organizations.

11 ABC Vs Absorption Costing Vs Marginal Costing ABC ABC absorbs product + selling + admin overheads in product cost

Absorption Costing Absorption costing conventionally absorbs only production overheads in product cost.

ABC gives more realistic Absorption costing and detailed information makes use of subjective for product costing and basis for allocation, long-term decisionapportionment and making purpose such as absorption of overheads product pricing.

Example: Floor area for rent As it considers all the costs as variable in long- apportionment and machine or labour hours term. ABC focuses on for absorption. activities and includes most of the Therefore, it is of little organizational cost in use in decision-making, product cost. and product costing based on absorption However, there is still costing can be subjective grouping of costs into cost pools and misleading. identification of cost drivers.

ABC can be used for Absorption costing can financial reporting be used for financial purpose reporting purpose.

Marginal Costing Marginal costing does not include fixed costs, even fixed production overheads in product cost.

Marginal costing is suitable for short-term decision-making.

Example: Decisions for accepting or rejecting customer order.

As it only considers variable costs and ignores fixed costs. It does not ensure full recovery of fixed cost in long-term.

Marginal costing is not allowed for financial reporting purpose by IAS 2 inventory.

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Performance Management | Page 31 of 106 Chapter 1: ACTIVITY BASED COSTING

ABC ABC allocates cost according to the activity and volume consumed by each product.

As it recognizes the difference between cost increasing with volume (volume based cost drivers) and cost increasing with activities (activity based cost drivers)

Absorption Costing Absorption costing allocates more overhead costs to high volume products and low activity products.

Marginal Costing

Conversely, it allocates less overhead costs to low volume high activity products.

It leads to dysfunctional (misleading) decisionmaking.

It leads to more accurate product costing and pricing.

12 Practice Question & Solution 12.1 Question Triple Limited makes three types of 8old watch the Diva (D), the Classic (C) and the Poser (P). A traditional product costing system is used at present; although an activity based costing (ABC) system is being considered. Details of the three products for a typical period are: —

Hours per unit Materials Production Labour hours Machine hours Cost per unit ($) Units Product D ½ 1½ 20 750 Product C 1½ 1 12 1,250 Product P 1 3 25 7,000

Direct labour costs $6 per hour and production overheads are absorbed on a machine hour basis. The overhead absorption rate for the period is $28 per machine hour.

Total production overheads are $654,500 and further show that the total production overheads can be divided as follows. % Costs relating to setups

35

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Performance Management | Page 32 of 106 Chapter 1: ACTIVITY BASED COSTING

% Costs relating to machinery Cost relating to materials handling Costs relating to inspection Total production overhead

20 15 30 100

The following total activity volumes are associated with each product line for the period as a whole.

Number of Number of movements Product D Product C Product P

set ups 75 115 480 670

of materials 12 21 87 120

Number of inspections 150 180 670 1,000

Required: a) Calculate the cost per unit for each product using traditional methods, absorbing overheads based on machine hours. b) Calculate the cost per unit for each product using ABC principles (work to two decimal places). c) Explain why cost per unit calculated under ABC are often very different to costs per unit calculated under more traditional methods. Use the information for triple limited to illustrate. d) Discuss the implications of a switch to ABC on pricing and profitability.

Solution (a)

Material Labour Production overhead Cost per unit

Diva

Classic

Poser

$

$

$

20 ($6 x ½hr) 3 ($28 x 1.5hrs) 42 65

12 ($6 x 1.5hrs) 9 ($28 x 1hr) 28 49

25 ($6 x 1hr) 6 ($28 x 3) 84 115

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Performance Management | Page 33 of 106 Chapter 1: ACTIVITY BASED COSTING

Marking Scheme For each product 1 mark Total 3 marks

(b) Let use step-by-step procedure to solve this question (this representation is for tutorial purpose and lengthier than you would be expected to fulfil requirement. Past paper is more useful for planning your representation for exam purpose).

Cost Per Unit Workings Material Labour Overhead

Diva ($) 20 3 94.95

($77,213/750) ($98,843/1,250)

Classic ($) 12 9

Poser ($) 25 6

79.07

($484,444/7,000) Cost per unit

117.95

100.07

69.21 100.21

Workings: Examiners Note: Each step required has been given its own sub-heading to make the procedure clear. The basic principle is to find an overhead cost per unit of activity for each element of overhead cost. In some cases, it might be possible to find an overhead cost per unit directly; here it is probably easier to split overhead between each product type first and then find a cost per unit as shown.

(Optional) Cost Pool Set up cost

Cost driver Number of setups

Machining cost

Machine hours

Material handling cost

Material movement

Reasons Set up cost arises each time new batch of production in launched.

It rises due to depreciation and maintenance of machine.

It arises each time material is moved around the factory.

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Performance Management | Page 34 of 106 Chapter 1: ACTIVITY BASED COSTING

Cost Pool Inspection cost

Cost driver Number of inspections

Reasons Inspection cost arises each time inspection is made.

Calculating Total Machine Hours Products Diva Classic Poser

Machine hour/unit ½ 1 3

Total number of units 750 1,250 7,000

Total machine hours 1,125 1,250 21,000 23,375

Cost Per Driver Calculation Cost Pools Set-ups Machining Materials handling Inspection

%

Apportioned cost ($) 35 229,075 20 130,900 15 98,175 30 196,350

Cost Driver Number of set ups Machine hours Material movements Number of inspections

Activity level 670 23,375 120

Cost per driver ($) 341.90 5.60 818.13

1,000

196.35

100 654,500

Overhead Split by Product Table Set-ups Machining Material Handling Inspection Total Overheads

Cost per driver ($) 341.90 5.60 818.13 196.35

Diva ($) 25,643 6,300 9,817 29,453 77,213

Respective activities 75 : 115 : 408 1,125 :1,250 :21,000 12 :21 : 87 150 : 180 : 670

Marking Scheme Total machine hours Cost per driver calculation Overheads split by product table Cost per unit calculation Total

Classic ($) 39,319 7,000 17,181 35,343 98,843

Poser ($) 164,113 117,600 71,177 131,554 484,444

Total ($) 229,075 130,900 98,175 196,350 654,500

2 marks 3 marks 4 marks 3 marks 12 marks

Exam Support Use tabular approach to save time and enhance representation and understanding.

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Performance Management | Page 35 of 106 Chapter 1: ACTIVITY BASED COSTING

Volume in units Absorption costing Activity based costing

Diva (1,125 Mac hrs) 750 $42 $95

Classic (1,250 Mac hrs) 1,250 $28 $79

Poser (21,000 Mac hrs) 7,000 $84 $69

Absorption costing allocates more overheads to high volume (machine hours) products such as poser and allocates less overheads to low volume products such as diva and classic.

Activity based costing allocates more overheads to product consuming more activities such as Diva and allocates less overheads to products consuming less activities such as classic and poser.

In this case machining cost is (130,900/654,500) 20% of total overheads incurred due to machine hours (volume) while the rest of the overheads 80% related to above activities.

It would be unfair to absorb all the overheads on basis of volume (machine hours). ABC costing recognizes this flaw, and absorbs overheads using variety of activity based cost drivers (number of setups) and volume related cost driver (machine hours) giving true reflection of cost incurred in production of each product.

Product Diva (D) has incurred (75/670) 11% setup cost while amounting to only (750/23000) 3.26% of total production volume. Therefore, ABC gives more weight based on activity when allocating setup cost to products as it should be, while absorption gives less weight based on volume when allocating setup cost to products.

Marking Scheme Explanation 4 marks Total 4 marks

Solution to Requirement (D) Volume in units Absorption costing Activity based costing

Diva (1,125 mac hrs) 750 $42 $95

Classic (1,250 mac hrs)1,250 $28 $79

Poser (21,000 mac hrs) 7,000 $84 $69

Exam Support Do not reproduce same comments repeatedly in exams. Doing so will not earn you marks instead it will consume time.

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Performance Management | Page 36 of 106 Chapter 1: ACTIVITY BASED COSTING

If triple ltd is using full cost plus pricing without considering market conditions, then it would be selling its lower cost products Diva and Classic at lower selling price and higher cost products at higher selling price.

On the basis absorption costing, product Diva and Classic would be sold at lower price and poser at higher prices. It might lead to losses on lower cost products (Diva and Classic) seems to be profitable to triple ltd and higher cost product might be discontinued as it seems uneconomical to customers in comparison with its Quality due to lower activity consumption such as number of inspections.

Therefore, absorption costing would encourage managers to produce more and more units of lower cost products and reducing or eliminating the production of higher cost products. It results in dysfunctional (misleading) decision-making.

Under ABC manager will have true information related to cost of each product, so competitive selling price can be charged to customers to competitive advantage in the market.

In price sensitive market, product Poser should be given first priority and product Diva should be given least priority. This will increase overall profitability of triple ltd.

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Performance Management | Page 37 of 106 Chapter 2: LIFE CYCLE COSTING

Chapter 2:

LIFE CYCLE COSTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 What Is Life Cycle Costing 2 Stages of Product Life Cycle 3 Benefits of Product Life Cycle Costing

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Performance Management | Page 38 of 106 Chapter 2: LIFE CYCLE COSTING

1 What Is Life Cycle Costing Life cycle costing is the cost management approach for managing products, functions, division and organization as a whole.

For now, we will discuss it for products only.

2 Stages of Product Life Cycle Diagram:

2.1 Design or Development Stage  Product is being planned.  Costs are being incurred resulting in negative cash flows.  There is no revenue at this stage.

2.2 Introduction  Product is first launched in the market.  Marketing expenditure is high due to the need for increasing demand for the new product, as customers are unaware of the product and its features.

Product cost per unit is high because of:  Greater material wastages due to labour are learning production process.

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Performance Management | Page 39 of 106 Chapter 2: LIFE CYCLE COSTING

 Labours working are less efficiently on new product than on existing products.  Overhead cost is also high because of lower production volume, production in small batches and ordering materials in small quantities.  Costs are still greater revenues resulting in negative cash balance.

2.3 Growth  Product starts to gain popularity as more and more customers are being aware of product and its features.  Marketing expenditure is slightly lower than that at introduction stage.

Product cost per unit gradually reducing because of:  Lower material wastages due to labours are learning the production process.  Labours are increasing being efficient and labour cost per unit in decreasing.  Overhead cost is decreasing due to lower production volume, production in large batches and obtaining bulk purchase discounts for ordering large quantities of material.  Revenue is increasing gradually resulting in positive cash balance.  New competitors are entering the market or developing the similar products.

2.4 Maturity  Product has achieved its full growth potential and product is well known amongst customers.  Marketing expenditure is at minimum at this stage, just to maintain and gain market share. Further expansion of market itself is not possible.

Product cost per unit is lowest at this stage because of:  Economies of scale (bulk purchase discounts) are achieved due to mass (bulk) production volumes.

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Performance Management | Page 40 of 106 Chapter 2: LIFE CYCLE COSTING

 Labour efficiency is increased to its full potential. Labours are making more products per hour resulting in reduced labour cost.  Overhead cost low due to economies of scales.  Products are of high quality and reduce warranty claim cost.  Minimal training and supervision cost than above stages.  Revenues are at peak and product is generating high cash flow balance ever.  Competitor try to penetrate (enter) the market reducing their selling price.

This puts increased demand for product quality to maintain selling price.

2.5 Decline  Customers are getting bored of the product and looking for other products offered by competitor or newer version of existing product.  Marketing expenditure can generate some interest in product particularly in lower income group.

Product cost begin to rise because of  Production volume is reduced due to reduction in demand, resulting in loss of economies of scale.  Changes in product design can increase the life of products perhaps at some costs. Cost should only be incurred if expected benefits are greater than cost.  Product can still be profitable (cash generating) because of competitors leaving the market. As a result price pressures are decreased and organization can enjoy monopoly position in the market.  Competitor may leave because find the market unattractive and want to pursue other interests.  Finally, at the end of life cycle product is discontinued.

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Performance Management | Page 41 of 106 Chapter 2: LIFE CYCLE COSTING

3 Benefits of Product Life Cycle Costing Product life cycle enables managers to take better strategic decisions regarding development and discontinuation of products.

Product life cycle recognizes the profitability over the whole life of the product.

As you have noticed that products tend to make loss (negative cash balance) in early stages of life cycle, then it would be more wise to look at product profitability over it whole life.

Other costing techniques (ABC, Absorption costing and marginal costing) excluding target costing do not recognizes this fact and tend to focus on profitability in short-term (1 year). It leads to dysfunctional (misleading) decision-making. It drops product, which are profitable during its whole life but loss making in earlier stages of its life cycle.

Product life cycle demonstrate the importance of timing to be considered in developing and introducing to the market. Earlier the organization launches its product more time it will have as a monopolist. This will result in more profitability from the product over its life cycle.

Conversely, voidable delays in developing and introducing the product can erode profitability of the product. Hence, time management and scheduling is important for product profitability.

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Performance Management | Page 42 of 106 Chapter 3: TARGET COSTING

Chapter 3:

TARGET COSTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 What Is Target Costing?

2 Steps Involved In Target Costing 3 Calculating Target Cost/Unit & Cost Gap 4 Strategies to Reduce Cost 5 Benefits of Target Costing 6 Target Costing In Service Industries

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Performance Management | Page 43 of 106 Chapter 3: TARGET COSTING

1 What Is Target Costing?

Target costing is the market (customer) focused cost reduction and control technique for potential and existing products.

Target recommends cost should be incurred for those product features, which add value (benefit) to the customer from customers’ viewpoint. All other costs should be eliminated or reduced to minimum.

Target costing is the continuous activity to improve product features and minimizes cost without losing value of the product in the eyes of the customer.

Improvement is sought over the whole product life cycle.

2 Steps Involved In Target Costing 2.1 Step1 Identify the market selling price for same or similar product.

2.2 Step2 Decide the desired profit margin that should be obtained.

2.3 Step3 Deduct the desired profit margin from market selling price of the product to arrive at Target cost (expected cost).

2.4 Step4 Estimate cost of product based on internal data on material, labour and overhead to be applied to the product.

2.5 Step5 Expected cost (step4) is then compared with estimated or budgeted cost (step5). The resulting difference is called target cost gap.

2.6 Step6 Aim to reduce target cost gap by using cost reduction strategies.

2.7 Step7 Once the target cost gap is filled, expected cost should be lowered further to achieve future improvements in the product and production process to reduced cost.

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Performance Management | Page 44 of 106 Chapter 3: TARGET COSTING

These steps will be continuously repeated until the end of product life cycle.

Diagram: Estimated cost

Target cost gap

Target cost

3 Calculating Target Cost/Unit & Cost Gap Illustration: Edward Co assembles and sells many types of radio. It is considering extending its product range to include digital radios. These radios produce a better sound quality than traditional radios and have a large number of potential additional features not possible with the previous technologies (station scanning, more choice, one touch tuning, station identification text and song identification text etc).

A radio is produced by assembly workers assembling a variety of components.

Production overheads are currently absorbed into product costs on an assembly labour hour basis.

Edward Co is considering a target costing approach for its new digital radio product.

A selling price of $44 has been set in order to compete with a similar radio on the market that has comparable features to Edward Co’s intended product.

The board have agreed that the acceptable margin (after allowing for all production costs) should be 20%.

Cost information for the new radio is as follows:

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Performance Management | Page 45 of 106 Chapter 3: TARGET COSTING

Component 1 (Circuit board) — these are bought in and cost $410 each. They are bought in batches of 4,000 and additional delivery costs are $2,400 per batch.

Component 2 (Wiring) — in an ideal situation 25 cm of wiring is needed for each completed radio. However, there is some waste involved in the process as wire is occasionally cut to the wrong length or is damaged in the assembly process. Edward Co estimates that 2% of the purchased wire is lost in the assembly process. Wire costs $050 per metre to buy.

Other material - other materials cost $8 10 per radio.

Assembly labour — these skilled people are difficult to recruit and retain.

Edward Co has more staff of this type than needed but is prepared to carry this extra cost in return for the security it gives the business. It takes 30 minutes to assemble a radio and the assembly workers are paid $1260 per hour. It is estimated that 10% of hours paid to the assembly workers is for idle time.

Production Overheads recent historic cost analysis has revealed the following production overhead data: Total production Total assembly overhead labour hours $ Month 1 620,000 19,000 Month 2 700,000 23,000 Fixed production overheads are absorbed on an assembly hour basis based on normal annual activity levels. In a typical year 240,000 assembly hours will be worked by Edward Co. Required: Calculate the expected cost per unit for the radio and identify any cost gap that might exist.

Solution: Component 1

Workings 4.10+($2,400/4,000)

$/unit Explanation 4·70 Material cost + delivery cost

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Performance Management | Page 46 of 106 Chapter 3: TARGET COSTING

Component 2

Other material Labour cost Variable production overhead (W1) Fixed production overhead (W1) Estimated or budgeted cost Expected or desired cost Cost gap

Workings 25/100 x 100/98 x $0.5

$/unit Explanation 0·128 Centimetre to metre x gross up for wastages x material cost 8.10 7 0.5 hours x gross up for idle time x labour rate 10 Variable overhead incurred during labour making products.

6 Fixed overhead absorbed on the basis of labour hours 35·928 Based on management accounting information 35.20 Market selling price less desired profit margin.

0.728 Cost reduction required.

30/60 x 100/90 x $12.60 30/60 x $20

30/60 x $12

$44 x(100-20)%

Workings High low method to variable and fixed components of overhead cost.

At 23,000 labour hours (highest activity level)

4 Strategies to Reduce Cost  Product features can be changed to reduce non-value adding features.  Providing training to labours to become more efficiency provided benefit exceeds cost.  Providing better working conditions to labours to improve motivation and so efficiency.

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Performance Management | Page 47 of 106 Chapter 3: TARGET COSTING

 Re-design production process to reduce non-value adding activities.  Outsourcing supporting (non-core) activities and automating perhaps by using information technology.  Change the type of material used without compromising quality.  Employee more unskilled labour by replacing them with existing skilled labours, if doing so will not deteriorate quality of the product.  Reduce labour turnover to benefit from labour learning and experience.

Points you make should be justified with reference to relevant information given in the scenario.

5 Benefits of Target Costing  Target costing attempts to manage costs at an early stage (development) of the product life cycle.  Most of the cost relating to product (high tech) incurs at development stage and it more beneficial to control and reduce cost at this stage.  In today modern environment product life cycle is getting shorter due to technological advancement rendering products obsolete, such as mobile phones.  Target costing determines the suitability of product for organization from market view point. If product is not suitable (desired profit margin cannot achieved) than product can be discontinued before investing resources in further development and production.  Target costing enables organization to achieve advantage over competitors by seeking continuous improvement over the whole product life cycle.

6 Target Costing In Service Industries In service industries, it is difficult to find same or similar services to identify the market price for service being provided or to be provided by the organization.

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Performance Management | Page 48 of 106 Chapter 3: TARGET COSTING

Even if the comparable services can be found it is still difficult to apply its price to the services of the organization.

It is due to the characteristics of services (intangible, perishable, heterogeneous, simultaneous and no transfer of ownership).

There can be more than one organization charging different prices for their same or similar services. Then it becomes a subjective (biased) matter of judgement.

In service industries person incurring the cost is not the person responsible for costs. It adds difficulty in managing costs.

Example: In hospital, costs are incurred because of decision taken by doctors and the responsibility to manage costs relies on administration staff.

Also in service industries cost managers has no control over process of providing the service. It is because of services are of technical in nature and cost manager may not have such technical skills.

Example: If you are assumed as cost controller then may not control the way mechanic repairs your car.

Each time service is provided, it results in different cost and quality.

Example: Hairdresser takes different amount of time each time you visit saloon.

Sometimes haircutting may not result as you wished.

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Performance Management | Page 49 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

Chapter 4:

THROUGHPUT ACCOUNTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 What Is Throughput Accounting 2 Principle Resource Factor 3 Calculating Throughput Accounting Ratio (TPAR) 4 Calculating Optimal Product or Process Mix

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Performance Management | Page 50 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

1 What Is Throughput Accounting 1.1 Throughput Definition Throughput is profit achieved after deducting direct material cost from selling price of product.

All remaining conversion costs (labour + overhead) are assumed as fixed for the whole period i.e. short-term.

Reason: Labours are increasingly becoming fixed cost due salaries and minimum wage rate requirements imposed by legislation.

Overhead cost are increasing become fixed due to outsourcing of various supporting business activities (internal audit) for a fixed monthly or yearly fee.

Managers trying to make longer term (long-term loan) agreements (contracts) to reduce risk and uncertainty in decision-making.

It means the only cost, which is variable in short-term, is direct material cost.

Throughput (profitability) can be maximized by using material more efficiently.

Examples: Throughput can be maximized using just in time (JIT) inventory management system to save inventory ordering cost.

Total quality management (TQM) to reduce material wastage, ideally eliminate.

2 Principle Resource Factor Principal resource is the resource (Labour or Machine) restricting the production volume of the products.

Other name for principal resource is principal factor, limiting resource or factor, constraint and bottleneck.

However, terminology used in F2 paper is principal resource.

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Performance Management | Page 51 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

2.1 Identifying Principal Resource Factor Formula:

This formula is applied for each process or resource over number of products given in question.

Process or resource giving lowest number of units for products in total is the principal resource factor.

Illustration: The factory has 50 production lines each of which contain the three processes: Raw material for the sheet metal is first pressed then stretched and finally rolled. The processing capacity varies for each process and the factory manager has provided the following data: Processing time per metre in hours Product A Product B Product C Pressing 0.50 0.50 0.40 Stretching 0.25 0.40 0.25 Rolling 0.40 0.25 0.25 The factory operates for 18 hours each day for five days per week. It is closed for only two weeks of the year for holidays when maintenance is carried out.

On average one hour of labour is needed for each of the 225,000 hours of factory time. Labour is paid $10 per hour.

Required: Identify the bottleneck process and briefly explain why this process is described as a ‘bottleneck’.

Solution: Products

A

B

C

Total

Pressing (W1) 450,000 450,000 562,500 1,462,500 Stretching 900,000 562,500 900,000 2,362,500 Rolling 562,500 900,000 900,000 2,362,500

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Performance Management | Page 52 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

Pressing process has the ability to make lowest number of units is the bottleneck process. Hence, it is limiting the capacity of Yam co to make more than 1,462,500 units during factory hours.

Workings Budgeted factory hours given is 225,000 hrs. It can also be calculated as follows

Pressing Process

3 Calculating Throughput Accounting Ratio (TPAR) Formulae:

It is assumed that material will always available in full supply.

Above formula gives throughput generating ability of a product in each scarce hour.

It enables managers to take short-term decisions on deciding which product will be made more and which product will be made less.

Product generating greater throughput will be given higher rank in resource allocation.

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Performance Management | Page 53 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

Where

Factory hours are the number of hours for which factory gate remains open Example: 5 workers work 5,000 hours per year during the same timings. Factory hours will be 5,000 hrs because it does not matter how many hours are paid per year, what matter is how long factory remained open per year.

This formula compares throughput on principal resource with conversion cost incurred for whole factory during factory hours.

If TPAR is greater than 1, it means product is generating more cash (throughput) than cash spent on running the factory.

If TPAR is lesser than 1, it means product is losing cash in each hour product is made in the factory. It is due to cash generated from product is less than cash spent on running the factory.

That product should be discontinued unless needed for other strategic purpose.

Illustration: Thin Co is a private hospital offering three types of surgical procedures known as A, B and C. Each of them uses a pre-operative injection given by a nurse before the surgery. Thin Co currently rent an operating theatre from a neighbouring government hospital. Thin Co does have an operating theatre on its premises, but it has never been put into use since it would cost $750,000 to equip. The Managing Director of Thin Co is keen to maximise profits and has heard of something called ‘throughput accounting’, which may help him to do this. The following information is available:  All patients go through a five step process, irrespective of which procedure they are having: Buy Full Performance Management Book (375±) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 54 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

– step 1: consultation with the advisor; – step 2: pre-operative injection given by the nurse; – step 3: anaesthetic given by anaesthetist; – step 4: procedure performed in theatre by the surgeon; – step 5: recovery with the recovery specialist.  The price of each of procedures A, B and C is $2,700, $3,500 and $4,250 respectively.  The only materials’ costs relating to the procedures are for the preoperative injections given by the nurse, the anaesthetic and the dressings.

These are as follows: Procedure A Procedure B Procedure C $ per $ per $ per procedure procedure procedure Pre-operative nurse’s injections 700 800 1,000 Anaesthetic 35 40 45 Dressings 5.60 5.60 5.60  There are five members of staff employed by Thin Co. Each works a standard 40-hour week for 47 weeks of the year, a total of 1,880 hours each per annum. Their salaries are as follows: – Advisor: $45,000 per annum; – Nurse: $38,000 per annum; – Anaesthetist: $75,000 per annum; – Surgeon: $90,000 per annum; – Recovery specialist: $50,000 per annum.

The only other hospital costs (comparable to ‘factory costs’ in a traditional manufacturing environment) are general overheads, which include the theatre rental costs, and amount to $250,000 per annum.  Maximum annual demand for A, B and C is 600, 800 and 1,200 procedures respectively. Time spent by each procedure is as follows: Buy Full Performance Management Book (375±) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 55 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

Procedure A Procedure B Procedure C Hours Hours Hours per procedure per procedure per procedure Advisor 0.24 0.24 0.24 Nurse 0.27 0.28 0.30 Anaesthetist 0.25 0.28 0.33 Surgeon 0.75 1 1.25 Recovery specialist 0.60 0.70 0.74 Part hours are shown as decimals e.g. 0·24 hours = 14·4 minutes (0·24 x 60).

Surgeon’s hours have been correctly identified as the bottleneck resource.

Required: a) Calculate the throughput accounting ratio for procedure C. Note: It is recommended that you work in hours as provided in the table rather than minutes. b) The return per factory hour for products A and B has been calculated and is $2,612·53 and $2,654·40 respectively. The throughput accounting ratio for A and B has also been calculated and is 8·96 and 9·11respectively.

Calculate the optimum product mix and the maximum profit per annum.

Solution to Requirement (a)

Therefore conversion cost per hospital hour = $548,000/1,880 = $291·49. $/unit 4,250

Selling price Material cost Pre-operative nurse’s injections Anaesthetic Dressings Throughput

1,000 45 5·60

1,050.60 3,199·40

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Performance Management | Page 56 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

Procedure C generates more throughput than costs incurred during operation of hospital.

Solution to Requirement (b) A TPAR 8·96 RANK 2

B 9·11 1

Optimal Production Mix Procedure (product) Demand Hrs/unit A 800 1 B 600 0.75 C 504 1.25 Total Maximum Profit Per Annum Throughput per bottleneck Hours taken hour 800 2,654·40 450 2,612·53 630 2,559·52 1,880

C 8·78 3

Hours taken 800 450 630 1,880

Total throughput 2,123,520 1,175,638·5 1,612,497·6 4,911,656·1

4 Calculating Optimal Product or Process Mix This is the second stage in throughput accounting after deciding whether to produce a product at all or not. Now, we will consider: Buy Full Performance Management Book (375±) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 57 of 106 Chapter 4: THROUGHTPUT ACCOUNTING

What product should be made first to make sure it gets sufficient resources to meet the demand with respect to it.

How much of each product should be made taking account of any principle factor associate with product (government restriction to make above certain level) or production process (availability of resources such as labour hours and machinery condition).

Illustration: The return per factory hour for products A and B has been calculated and is $2,612·53 and $2,654·40 respectively. The throughput accounting ratio for A and B has also been calculated and is 8·96 and 9·11respectively.

Required: Calculate the optimum product mix and the maximum profit per annum.

Solution to Requirement (b) A TPAR 8·96 RANK 2

B 9·11 1

C 8·78 3

Optimal Production Mix Procedure (product) Demand Hrs/unit Hours taken A 800 1 800 B 600 0.75 450 C 504 1.25 630 Total 1,880 Maximum Profit Per Annum Hours taken Throughput per bottleneck hour 800 2,654·40 450 2,612·53 630 2,559·52 1,880

Total throughput 2,123,520 1,175,638·5 1,612,497·6 4,911,656·1

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Performance Management | Page 58 of 106 Chapter 5: ENVIRONMENTAL ACCOUNTING

Chapter 5:

ENVIRONMENTAL ACCOUNTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Environmental Management Accounting 2 Benefits of Environmental Management Accounting 3 Methods of Environmental Accounting

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Performance Management | Page 59 of 106 Chapter 5: ENVIRONMENTAL ACCOUNTING

1 Environmental Management Accounting 2 Benefits of Environmental Management Accounting 3 Methods of Environmental Accounting 3.1 Activity Based Costing 3.2 Life Cycle Costing

4 Types of Environmental Cost 4.1 Prevention Cost 4.2 Detection Cost 4.3 Internal Failure Cost 4.4 External Failure Cost

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Performance Management | Page 60 of 106 Chapter 6: RELEVANT COSTING

Chapter 6:

RELEVANT COSTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Relevant Cost Vs Irrelevant Cost 2 Materials 3 Labour 4 Overheads

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Performance Management | Page 61 of 106 Chapter 6: RELEVANT COSTING

1 Relevant Cost Vs Irrelevant Cost 1.1 Types of Relevant Cost 1.1.1 Future Cost 1.1.2 Avoidable Cost 1.1.3 Controllable Cost 1.1.4 Replacement Cost 1.1.5 Net Realisable Value 1.1.6 Variable Cost 1.1.7 Opportunity Cost 1.1.8 Directly Attributable Fixed Cost 1.2 Types of Irrelevant Costs 1.2.1 Past or Sunk Cost 1.2.2 Committed Cost 1.2.3 Fixed Cost 1.2.4 Original Purchase Cost 1.2.5 Non-Cash Expenses

2 Materials 2.1 Spare Materials 2.2 Material in Use

3 Labour 3.1 Spare Labour 3.2 Labour in Use

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Performance Management | Page 62 of 106 Chapter 6: RELEVANT COSTING

4.1 Variable Overhead 4.2 Fixed Overhead

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Performance Management | Page 63 of 106 Chapter 6: RELEVANT COSTING

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Performance Management | Page 64 of 106 Chapter 7: SHORT TERM DECISION-MAKING

Chapter 7:

SHORT-TERM DECISION-MAKING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Outsourcing Benefits & Limitations 2 Incremental Costs & Revenues 3 Make or Buy Decision 4 Continue or Discontinue Decision 5 Further Processing Decisions 6 Non-Financial Factors Involved In Further Processing Decision

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Performance Management | Page 65 of 106 Chapter 7: SHORT TERM DECISION-MAKING

1 Outsourcing Benefits & Limitations 1.1 Benefits of Outsourcing 1.1.1 Economies of Scale 1.1.2 Planning & Budgeting 1.1.3 Realization of Surplus Assets 1.1.4 Elimination of Limiting Resources 1.1.5 Reduced Overhead Costs 1.1.6 Experience & Expertise 1.1.7 Focus On Core Activities 1.2 Limitations of Outsourcing 1.2.1 Cost May Exceed Benefits 1.2.2 Employee Morale 1.2.3 Reaction of Stakeholders 1.2.4 Legislation 1.2.5 Lack of Autonomy 1.2.6 Loss of Control

2 Incremental Costs & Revenues 3 Make or Buy Decision 4 Continue or Discontinue Decision 5 Further Processing Decisions 6 Non-Financial Factors Involved In Further Processing Decision 6.1 Financial Basis Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 66 of 106 Chapter 7: SHORT TERM DECISION-MAKING

6.2 Non-Financial Basis

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Performance Management | Page 67 of 106 Chapter 8: COST VOLUME PROFIT ANALYSIS

Chapter 8:

COST VOLUME PROFIT ANALYSIS Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Single Product Situation 2 Basic Terms 3 Multi Product Situation 4 Limitations of CVP Analysis

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Performance Management | Page 68 of 106 Chapter 8: COST VOLUME PROFIT ANALYSIS

1 Single Product Situation 1.1 Calculating Contribution to Sales (C/S) Ratio

2 Basic Terms 2.1 Breakeven Point (BEP) 2.2 Margin of Safety (MOS) 2.3 Calculating Breakeven Point 2.4 Calculating Margin of Safety 2.5 Calculating Target Profit or Revenue

3 Multi Product Situation 3.1 Calculating C/S Ratio 3.2 Calculating Breakeven Point 3.3 Calculating Target Profit or Revenue

4 Limitations of CVP Analysis

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Performance Management | Page 69 of 106 Chapter 9: PRICING DECISIONS

Chapter 9:

PRICING DECISIONS Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Pricing Strategies 2 Calculating Prices for Different Pricing Strategies 3 Price Demand Relationship 4 Price Elasticity of Demand 5 Calculating Price Elasticity of Demand 6 Determining Optimal Selling Price, Sales Volume & Profit 7 Non-Financial Aspects of Pricing Decision

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Performance Management | Page 70 of 106 Chapter 10: LINEAR PROGRAMING

1 Pricing Strategies 1.1 Price Penetration 1.2

Discounted-Pricing

1.3 Volume Discounting 1.4 Price Skimming 1.5 Premium Pricing 1.6 Market Segmentation or Price Discrimination 1.7 Complementary Product Pricing 1.8 Product Line Pricing 1.9 Captive Product Pricing 1.10 Full Cost Plus Pricing 1.11 Marginal Cost Plus Pricing 1.12 Relevant Cost Pricing

2 Calculating Prices for Different Pricing Strategies

3 Price Demand Relationship 4 Price Elasticity of Demand 5 Calculating Price Elasticity of Demand 6 Determining Optimal Selling Price, Sales Volume & Profit 6.1 Straight Line Demand Equation 6.2 MC=MR (Marginal Cost Is Equal to Marginal Revenue)

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Performance Management | Page 71 of 106 Chapter 10: LINEAR PROGRAMING

7 Non-Financial Aspects of Pricing Decision

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Performance Management | Page 72 of 106 Chapter 10: LINEAR PROGRAMING

Chapter 10:

LINEAR PROGRAMING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Calculating Contribution 2 Calculating Optimal Production Plan for Maximizing Contribution 3 Calculating Shadow Price (Dual Price) & Slack 4 Extending Production beyond Existing Capacity 5 Revising Optimal Production Plan

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Performance Management | Page 73 of 106 Chapter 10: LINEAR PROGRAMING

1 Optimial Production Plan in Single Limiting Factor Situation 1.1 Calculating Contribution

2 Calculating Optimal Production Plan for Maximizing Contribution

3 Calculating Shadow Price (Dual Price) & Slack 4 Extending Production beyond Existing Capacity 5 Revising Optimal Production Plan

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Performance Management | Page 74 of 106 Chapter 11: RISK & UNCERTAINITY IN DECISION-MAKING

Chapter 11:

RISK & UNCERTAINTY IN DECISIONMAKING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Basic Terms 2 Construct Payoff Tables 3 Decision Rules 4 Sensitivity Analysis 5 Decision Tree

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Performance Management | Page 75 of 106 Chapter 11: RISK & UNCERTAINITY IN DECISION-MAKING

1 Basic Terms 1.1 Risk Vs Uncertainty 1.2 Decision-making 1.3 Outcome 1.4 Variables 1.5 Pay Off 1.6 Circumstances

2 Construct Payoff Tables 3 Decision Rules 3.1 Expected Value 3.2 Calculating Expected Value 3.3 Maximin Decision Rule 3.4 Maximax 3.5 Minimax Regret Rule

4 Sensitivity Analysis 4.1 Performing Sensitivity Analysis

5 Decision Tree

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Performance Management | Page 76 of 106 Chapter 12: LEARNING CURVE THEORY

Chapter 12:

LEARNING CURVE THEORY Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Learning Curve 2 Calculating Product Cost/Unit (Tabular Approach) 3 Calculating Product Cost per Unit (Statistical Approach) 4 Ways to Improve Learning Rate

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Performance Management | Page 77 of 106 Chapter 12: LEARNING CURVE THEORY

1 Learning Curve 2 Calculating Product Cost/Unit (Tabular Approach)

3 Calculating Product Cost per Unit (Statistical Approach) 4 Ways to Improve Learning Rate

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Performance Management | Page 78 of 106 Chapter 13: FORECASTING

Chapter 13:

FORECASTING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Scatter Graph Diagrams & Line of Best Fit 2 Coefficient Of Correlation 3 Regression Analysis 4 Calculating Regression Line Analysis 5 Adjustment for Inflation or Deflation 6 Advantages & Disadvantages of Regression Line Analysis 7 Time Series Analysis 8 Moving Averages 9 Seasonal Variations 10 Advantages & Disadvantages of Time Series Analysis

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Performance Management | Page 79 of 106 Chapter 13: FORECASTING

1 Scatter Graph Diagrams & Line of Best Fit 2 Coefficient Of Correlation 2.1 Calculating Co-Efficient Of Correlation 2.2 Coefficient of Determination

3 Regression Analysis 4 Calculating Regression Line Analysis 4.1 Assumptions of Regression Line Analysis

5 Adjustment for Inflation or Deflation 5.1 Consumer Price Index (CPI) or Retail Price Index (RPI) 5.2 Industry Specific Price Index

6 Advantages & Disadvantages of Regression Line Analysis 7 Time Series Analysis 7.1 Components of Time Series 7.1.1 Trend 7.1.2 Seasonal Variations 7.1.3 Cyclical Variations 7.1.4 Random Variations

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Performance Management | Page 80 of 106 Chapter 13: FORECASTING

9.1.1 Assumption 9.2 Multiplicative Model 9.2.1 Assumption 9.3 Deseasonalisation

10 Advantages & Disadvantages of Time Series Analysis

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Performance Management | Page 81 of 106 Chapter 14: BUDGETING SYSTEMS

Chapter 14:

BUDGETING SYSTEMS Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Uses of Budgeting 2 Preparing Flexible Budgets 3 Incremental Budgeting 4 Advantages & Disadvantages of Incremental Budgeting 5 Zero Based Budgeting (ZBB) 6 Process of Zero Based Budgeting 7 Advantages & Disadvantages of Zero Based Budgeting 8 Budgeting In Private Vs Public 9

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Performance Management | Page 82 of 106 Chapter 14: BUDGETING SYSTEMS

1 Uses of Budgeting 2 Preparing Flexible Budgets 3 Incremental Budgeting

4 Advantages & Disadvantages of Incremental Budgeting 5 Zero Based Budgeting (ZBB) 6 Process of Zero Based Budgeting 7 Advantages & Disadvantages of Zero Based Budgeting

8 Budgeting In Private Vs Public 9 Behavioural Aspects of Budgeting

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Performance Management | Page 83 of 106 Chapter 15: TYPES OF BUDGETING

Chapter 15:

TYPES OF BUDGETING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Importance of Principle Budget Factor 2 Sales Budget 3 Functional Budgets 4 Cash Budgets 5 Master Budgets

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Performance Management | Page 84 of 106 Chapter 15: TYPES OF BUDGETING

1 Importance of Principle Budget Factor 2 Sales Budget 3 Functional Budgets 3.1 Production Budget 3.1.1 Raw Materials Budget 3.1.2 Direct Labour Budget 3.1.3 Variable & Fixed Production Overhead Budget

4 Cash Budgets

5 Master Budgets 6 Behavioural Aspects of Budgeting 6.1 Advantages & Disadvantages of Participative Style of Budgeting 6.2 Top down Vs Bottom up Approach to Budgeting

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Performance Management | Page 85 of 106 Chapter 16: BASIC VARIANCE ANALYSIS

Chapter 16:

BASIC VARIANCE ANALYSIS Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Total Sales Variance 2 Total Material Cost Variance 3 Total Labour Cost Variance 4 Total Variable Production Overhead Variance 5 Total Fixed Production Overhead Variance 6 Interpreting Variances 7 Investigating Variances 8 Reasons for Variances 9 Interrelationship between Variances 10 Reconciling Budgeted & Actual Profits 11 Total Quality Management

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Performance Management | Page 86 of 106 Chapter 16: BASIC VARIANCE ANALYSIS

1 Total Sales Variance 1.1 Sales Price Variance 1.2 Sales Volume Profit or Contribution Variance

2 Total Material Cost Variance 2.1 Material Price Variance 2.2 Material Usage Variance

3 Total Labour Cost Variance 3.1 Labour Rate Variance 3.2 Labour Efficiency Variance 3.3 Idle Time Variance

4 Total Variable Production Overhead Variance 4.1 Variable Production Overhead Expenditure Variance 4.2 Variable Production Overhead Efficiency Variance

5 Total Fixed Production Overhead Variance 5.1 Fixed Production Overhead Expenditure Variance 5.2 Fixed Production Overhead Volume Variance 5.2.1 Fixed Production Overhead Efficiency Variance 5.2.2 Fixed Production Overhead Capacity Variance

6 Interpreting Variances

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Performance Management | Page 87 of 106 Chapter 16: BASIC VARIANCE ANALYSIS

7 Investigating Variances 8 Reasons for Variances 9 Interrelationship between Variances

10 Reconciling Budgeted & Actual Profits 10.1 Under Absorption Costing 10.2 Under Marginal Costing

11 Total Quality Management

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Performance Management | Page 88 of 106 Exam Topic 17: MIX & YIELD VARIANCES

Chapter 17:

MIX & YIELD VARIANCES Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Material Mix & Yield Variance 2 Sales Mix & Yield Variance

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Performance Management | Page 89 of 106 Exam Topic 17: MIX & YIELD VARIANCES

1 Material Mix & Yield Variance 1.1 Material Mix Variance 1.2 Calculating Material Mix Variance 1.3 Material Yield Variance 1.4 Calculating Material Yield Variance 1.5 Interrelationship b/w Material Price, Mix & Yield Variance

2 Sales Mix & Yield Variance 2.1 Sales Mix Variance 2.2 Calculating Sales Mix Variance 2.3 Sales Yield Variance 2.4 Calculating Sales Yield Variance 2.5 Interrelation b/w Sales Price, Mix & Yield Variance

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Performance Management | Page 90 of 106 Chapter 18: PLANNING & OPERATIONAL VARIANCE

Chapter 18:

PLANNING & OPERATIONAL VARIANCE Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Controllable Vs Non Controllable Costs 2 Revision of Budget 3 Planning & Operational Variances 4 Sales Planning & Operational Variance 5 Material Planning & Operational Variance 6 Labour Planning & Operational Variances

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Performance Management | Page 91 of 106 Chapter 18: PLANNING & OPERATIONAL VARIANCE

1 Controllable Vs Non Controllable Costs 2 Revision of Budget 3 Planning & Operational Variances 3.1 Planning Variance 3.2 Operational Variance

4 Sales Planning & Operational Variance 5 Material Planning & Operational Variance 5.1 Summary:

6 Labour Planning & Operational Variances 6.1 Summary:

7 Activity Based Variances

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Performance Management | Page 92 of 106 Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT

Chapter 19:

FINANCIAL PERFORMANCE MEASUREMENT Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Assessing Financial Performance Based On Ratio Analysis 2 Divisional Performance Measures 3 Advantages & Disadvantages of Both ROE & RI

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Performance Management | Page 93 of 106 Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT

1 Assessing Financial Performance Based On Ratio Analysis 1.1 Profitability Ratios 1.1.1 Gross Profit Margin 1.1.2 Net/Operating Profit Margin 1.1.3 Cost of Sales Percentage 1.1.4 Operating Cost Percentage

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Performance Management | Page 94 of 106 Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT

1.1.5 Sales Growth or Decline Percentage 1.2 Working Capital or Liquidity Ratios 1.2.1 Trade Receivable Turnover 1.2.2 Inventory Turnover 1.2.3 Trade Payable Turnover 1.2.4 Current Asset Ratio 1.2.5 Quick Ratio or Acid Test Ratio 1.3 Gearing Ratios 1.3.1 Financial Gearing Ratios 1.3.1.1 Debt to Equity Ratio 1.3.1.2 Debt to Debt plus Equity Ratio 1.3.2 Operational Gearing Ratio 1.3.2.1 Contribution to Profit before Interest & Tax (PBIT) 1.3.3 Interest Cover (Times) 1.4 Investor Ratios 1.4.1 Earnings Per Share (EPS) 1.4.2 Price Earnings (P/E) Ratio 1.4.3 Earnings Yield 1.4.4 Dividends Yield 1.4.5 Dividend Cover 1.4.6 Payout Ratio 1.5 Evaluating Performance Using Ratios

2 Divisional Performance Measures 2.1 Return on Capital Employed (ROCE) or Return On Investment (ROI) 2.2 Calculating ROCE or ROI Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 95 of 106 Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT

2.3 Return on Equity (ROE) 2.4 Calculating ROE 2.5 Residual Income (RI) 2.6 Calculating RI

3 Advantages & Disadvantages of Both ROE & RI

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Performance Management | Page 96 of 106 Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT

Chapter 20:

NON FINANCIAL PERFORMANCE MEASUREMENT Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Financial Vs Non-Financial Performance Measures 2 Critical Success Factors & Key Performance Indicators 3 Balance Score Card 4 Benefits & Limitations of Balance Score Card 5 Characteristics of Services Performance Measurement in Service Industries 6 Performance Measurement in Non Profit & Public 7 Benchmarking 8 Value for Money

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Performance Management | Page 97 of 106 Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT

1 Financial Vs Non-Financial Performance Measures 2 Critical Success Factors & Key Performance Indicators 2.1 Critical Success Factors (CSF) 2.2 Key Performance Indicators (KPI)

3 Balance Score Card 3.1 Financial Perspective 3.2 Customer Satisfaction Perspective 3.3 Internal Business Perspective 3.4 Innovation & Learning Perspective

4 Benefits & Limitations of Balance Score Card 5 Characteristics of Services 6 Performance Measurement in Service Industries 6.1 Standards 6.1.1 Equity 6.1.2 Ownership 6.2 Rewards 6.2.1 Motivation 6.2.2 Clear 6.2.3 Controllability 6.3 Dimensions 6.3.1 Determinants 6.3.1.1 Quality of Service Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 98 of 106 Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT

6.3.1.2 Flexibility 6.3.1.3 Innovation 6.3.1.4 Resource Utilization 6.3.2 Results 6.3.2.1 Financial Performance

6.3.2.2 Competitive Performance

7 Performance Measurement in Non Profit & Public 8 Benchmarking 8.1 Explanation of Benchmarking 8.2 Role of Benchmarking In Performance Measurement

9 Value for Money 9.1 Economy 9.2 Efficiency 9.3 Effectiveness 9.4 Performance Indicators 9.4.1 Economy 9.4.2 Efficiency 9.4.3 Effectiveness 9.5 Efficiency, Capacity & Activity Ratios 9.5.1 Efficiency Ratio 9.5.1.1 Limitation of Efficiency Ratio 9.5.2 Capacity Ratio 9.5.3 Activity Ratio Buy Full Performance Management Book (375Âą) at ACCASUPPORT.COM | NEWSLETTERS | COMMENT | FORUMS | JOBS Financial Management, Performance Management Business Analysis, Ebusiness / Ecommerce Guide Free Download

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Performance Management | Page 99 of 106 Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT

9.5.4 Calculate Efficiency, Capacity & Production Volume Ratios

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Performance Management | Page 100 of 106 Chapter 21: TRANSFER PRICING

Chapter 21:

TRANSFER PRICING Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Need for Transfer Pricing 2 Objectives of Transfer Pricing 3 Evaluating Transfer Price 4 Setting Transfer Price 5 Volume, Cost & Quality

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Performance Management | Page 101 of 106 Chapter 21: TRANSFER PRICING

1 Need for Transfer Pricing 2 Objectives of Transfer Pricing 2.1 Benefits of Internal Transfer 2.2 Limitations of Internal Transfer

3 Evaluating Transfer Price 3.1 Market Based Transfer Pricing 3.2 Cost Based Transfer Pricing 3.2.1 Full Cost Plus Pricing 3.2.2 Marginal Cost Plus Pricing 3.2.3 Marginal + Opportunity Cost Plus Pricing 3.3 Dual Transfer Pricing 3.4 Two Part Tariff Pricing

4 Setting Transfer Price 4.1 Lack of Spare Capacity (Unsatisfied Market Demand) 4.1.1 Maximum Transfer Price 4.1.2 Minimum Transfer Price 4.1.3 External Selling & Buying 4.2 Presence of Spare Capacity (Lack of Market Demand) 4.2.1 Maximum Transfer Price 4.2.2 Minimum Transfer Price 4.2.3 External Selling & Buying

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Performance Management | Page 102 of 106 Chapter 21: TRANSFER PRICING

2. Preparing Income Statement for Divisions

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Performance Management | Page 103 of 106 Chapter 22: BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT

Chapter 22:

BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT Sub Headings S.no Headings (click the Cross-ref below for easy navigation) 1 Performance Measurement & Human Resource 2 Manipulation of Performance Measures 3 Managerial Incentive Schemes 4 Rewarding Performance

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Performance Management | Page 104 of 106 Chapter 22: BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT

6 Performance Measurement & Human Resource 7 Manipulation of Performance Measures 7.1 Cut Off 7.2 Lagging Payments 7.3 Deferring Capital Expenditures 7.4 Early Settlement Discounts 7.5 Price Reduction

8 Managerial Incentive Schemes 8.1 Salary 8.2 Bonus 8.3 Shares 8.4 Share Options 8.5 Pension 8.6 Benefits

9 Rewarding Performance

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Performance Management | Page 105 of 106 This Material is Not Available Offline & Online in Any Form Except ACCASUPPORT.COM & CLICKBANK.COM

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Performance Management | Page 106 of 106 This Material is Not Available Offline & Online in Any Form Except ACCASUPPORT.COM & CLICKBANK.COM

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