MA 复习串讲

The nature,source and purpose fo management information (A)

Data analysis and statistical techniques (B)

Budgeting (D)

Standard costing (E) Cost accounting

techniques (C)

Performance
measurement (F)
MA is a two-hour computer-based examination.

The examination will consist of two sections:

No of marks
Section A
35 two mark objective test questions (OTs) 70
Section B
3 ten-mark multi-task questions (MTQs) 30
100

The multi-task questions in Section B will examine Budgeting, Standard costing and Performance
measurement sections of the syllabus.
Note: Budgeting MTQs in Section B can also include tasks from B2 Forecasting techniques. B4
Spreadsheets could be included in any of the MTQs, as either the basis for presenting information
in the question scenario or as a task within the MTQ.
Part A
The nature, source and purpose of
management information
Chapter 1
Accounting for management
 1.2.1 Managerial process of planning, control and decision making

Set goals and objectives

Identify alternative strategies which might accomplish the goals
Planning Evaluate each strategy by analysing the relevant information
Choose one of the alternative strategies
Implement the decision

Measure actual results

Control Compare the actual results with the plan to evaluate performance
Take action to the variance: review the plan or improve operation

Decision making
 1.2.2 Cost Accounting

Cost accounting is an essential function of management accounting. The field of

management accounting is broader than that of cost accounting. It uses the
information provided by this accountant and other internal and external information
collected to assist management.

Decisions made by management are judgments about the future involving the
assessment of risks and uncertainties. Therefore, the information needed to make
decisions should cover future risks and uncertainties. Cost information comes from
historical records, and if it is used as decision-making information, it must contain
content related to future uncertainties to a certain extent.
 1.2.3 Information requirement for management accounting

Long-term/corporate planning and control；

Top STRATEGIC overall/whole organization

TACTICAL/ Medium-term/corporate planning and control

Middle ensure resources are used efficiently and effectively
MANAGEMENT
Short-term/day to day planning and
Bottom OPERATIONAL control; specific task and routine task

Figure 1 - 1 Three types of management activity

The most information used by strategic managers is external information, and the lower the
level, the more internal information used and the less external information used.
 1.3.2 Comparison Table

Financial accounting Management accounting

Targeted User External and Internal Internal
Segment/Divisions or whatever is
Scope Whole organization
needed by business/Specific
Legal Requirement ✓ 

Frequency Annual As required

Past and present data to make
Timely Past data
decisions about future
Precision True and Fair As accurate as possible for users need

Format Governed by Companies Act No set format

Table 1 - 2 Management accounting VS Financial accounting

Chapter 2
Sources of data
 2.2 Types of data

2.2.1 Qualitative and Quantitative data

2.2.2 Discrete and Continuous data (Numerical data)

2.2.3 Nominal and Ordinal data (Categorical data)

2.2.4 Primary and Secondary data source

 2.3 Sources of data – from Sep. 2021(ACCA（n.d.))

a) Machine/sensor data
This data comes from the equipment used, such as sports bracelets.

b) Transactional data
This data comes from the transactions which are undertaken by the organisation, such as
purchasing orders.

c) Human/social data
This source is becoming more and more relevant to organisations. This source includes all
social media posts, videos posted etc., such as users’ behaviour records and feedback.
 2.4 Analyzing data – from Sep. 2021

a) Descriptive analysis 描述性分析

Understanding the broad overview of the data.

b) Inferential analysis 推断性分析

The analysis to derive inferences from data is called inferential analysis.
 2.5 Information

2.5.1 Financial and non-financial information

Information includes financial information and non-financial information. Financial information

refers to information that can be expressed in monetary value, such as operating income,
advertising costs, and the asset value of land and plant; non-financial information cannot be easily
expressed in monetary value, such as social responsibility, political status, environmental impact,
and brand awareness.
Because companies usually aim to increase shareholder wealth, financial information is often used
as the primary evaluation factor for decision-making, and solutions that are not feasible from a
financial perspective are often rejected by managers. But in fact, although some decisions are not
conducive to the financial performance of the company in the short term, they can bring long-term
non-financial competitive advantages to the company, such as customer satisfaction, enhancing
brand awareness and etc. Ignoring these aspects will cause a negative impact on the company or
even affects the financial performance. Therefore, managers should not be confined to financial
information, and non-financial information is also crucial in the decision-making process of a
company.
 2.5.2 Attributes of good information — ACCURATE

Accurate
Complete
Cost beneficial
User targeted/Understandable
Relevant
Authoritative
Timely
Easy to use
 2.8 Big Data

2.8.1 Definition: Big Data

Grable (2018, p.17) has stated, “big data refers to large data sets, collected by firms and
governments, that are so large and complex that traditional data processing methods are
inadequate to deal with the calculations needed to make sense of the data.”
 2.8.2 Concepts of big data

• Volume: the amount of data

• Velocity: the speed of collecting data
• Variety: the type of the collected data - structured data, semi-structured data and
unstructured data
• Value: the worth of the data being collected
• Veracity: accuracy and truthfulness and relates to the quality of the data
 2.8.4 Related data analytic techniques

Data mining, artificial neural networks and machine learning are the most commonly used
analytic techniques to deal with Big Data by businesses and governments and detailed
explanations are shown below:

Using existing information and data analytics to search for

Data mining
hidden or emerging patterns in data to explain a particular
数据挖掘：现有挖隐藏
phenomenon
a computer-based decision-making system for complex
Artificial neural networks data sets comprising processor nodes interconnected in a
人工神经网络：模拟人脑 weighted fashion, simulating a biologic nervous
system(Farlex, 2012).

Machine learning Gaining knowledge from existing data and patterns in data.
机器学习模型： This then provides the foundation for a machine or some
不断学习&提高 other form of artificial intelligence (AI) to teach itself.
Chapter 3
Cost Classification
 3.2 Cost classification

Total Costs

By function Production Non-production

By traceability Direct Indirect Indirect

By nature Material Labour Expenses Material Labour Expenses Material Labour Expenses

Prime costs Production Overheads Non-Production Overheads

Figure 3-1 Cost classification

 Ⅰ. Fixed Costs

y = cost per unit

y = total cost

Fixed cost: y = a Fixed cost per unit: y = a/x

x = level of activity (LoA) x = level of activity (LoA)

Figure 3-2 Fixed costs

Note: Fixed costs do not change with the level of activity; however, unit fixed costs show
a decreasing trend as output increases.
 II. Variable Costs

y = cost per unit

Total variable cost: y = bx
y = total cost

Variable cost per unit: y = b

x = level of activity (LoA) x = level of activity (LoA)

Figure 3-3 Variable costs

Note: The total variable cost increases with the increase in output, but the unit variable cost
remains the same.
 III. Mixed cost

(a) Step cost

‘A fixed cost that increases in steps is called a step cost.’ (Weetman, 2010, p.37)
For example: the rent of the warehouse, the labor cost of the supervisor (one supervisor is required
for every 5 workers).

y = total cost

x = level of activity (LoA)

Figure 3-4 Step costs

 III. Mixed cost

(b) Semi-Variable Costs

‘A semi-variable cost is one which is partly fixed and partly varies with changes in the level of
activity, over a defined period of time.’ (Weetman, 2010, p.37)
For example: telephone charges (monthly rent plus fees charged per minute), salesmen’s salary.

y = total cost

Total cost = FC +VC

y = a + bx

FC = a

x = level of activity (LoA)

Figure 3-5 Semi-variable costs

 I. High-low method

Lecture illustration:
GN is a cinema whose total costs for the last four months were recorded as follows.

$ Total Cost

Variable cost

Total cost

Fixed cost

Low High Number of audience

Figure 3-6 High-low method
Chapter 4
Presenting information
 4.1 Reports

Report is an organised format to present information and to initiate a decision or

action. (Report, 2019)

Note: Due to different objects and different purposes, we will use different styles of
reports to present information.

The following are the styles of various reports:

Reports that are prepared and submitted as a part of routine work and at a regular
interval is called routine reports. Reports that are prepared after an investigation, an
inquiry by an individual or a committee are called special reports.
 4.2 Tables

4.2.1 Introduction

A table is an arrangement of information in rows and columns, or possibly in a more

complex structure. Additionally, a table may have a title and shows two variables in two-
dimensional format. [Table (information), 2019]
4.3 Charts

Charts

Line graphs Bar charts Pie charts Scatter diagrams

Figure 4-1 Different types of charts

 4.3.3 Bar charts

A bar chart or bar graph is a chart or graph that presents categorical data with rectangular bars
with heights or lengths proportional to the values that they represent. The bars can be plotted
vertically or horizontally. (Bar chart, 2019)

Bar Charts

Simple Bar Component Bar Multiple Bar

Charts Charts Charts

Percentage
Component Bar
Charts

Figure 4-3 Different types of bar charts

Part B
Data analysis and statistical techniques
Chapter 5
Statistics for Management Accounting

32
 5.1.1.2 Measures of dispersion

Coefficient of variation
The coefficient of variation is equal to the standard deviation divided by the mean, multiplied by 100%.

𝜎
𝐶𝑉 = (Given in exam)
𝑥ҧ
𝜎
Population coefficient of variance (CV) = × 100%
𝜇
𝑠
Sample coefficient of variance (CV) = × 100%
𝑋ത

For lecture example 6, the coefficient of variance for X: = 3.69/14× 100% = 26.36% .

When two sets of data use different units of measurement, the CV method is the best way to compare the
deviations.
33
 5.1.1.3 Measures for grouped data

Mean for grouped data

Grouped data: data that have been grouped into a frequency distribution.

For example, some universities divide students mark into five grades:
High Distinction (80–100), Distinction (70–79), Credit (60—69), Pass (50—59) and Fail (0—49).

In most cases, the secondary information is a sorted frequency distribution and the user does not
have access to the ungrouped raw data. In this case, only the approximate average can be found.

The average value of the grouped data can be approximately calculated by the following steps:
1. Find the midpoint of each group;
2. Multiply the midpoint of each group by the number of observations and add them up.
3. Divide the sum in step 2 by the total number of observations

34
 5.1.1.3 Measures for grouped data

Mean for grouped data

Formula in ACCA MA exam,

σ 𝑓𝑥
𝑋ത = (Given in exam)
σ𝑓

f = the frenquency or number of observations in each group

x = the midpoint of each group
σ 𝑓 = the number of values in the data set

35
 5.1.1.3 Measures for grouped data

Variance for grouped data

Formula in ACCA MA exam,

2 2
2
σ 𝑓𝑥 σ 𝑓𝑥
𝜎 = −
σ𝑓 σ𝑓

f = the frenquency or number of observations in each group

x = the midpoint of each group
σ 𝑓 = the number of values in the data set

Standard deviation for grouped data

2
σ 𝑓𝑥 2 σ 𝑓𝑥 (Given in exam)
𝜎= −
σ𝑓 σ𝑓
36
 5.1.2 Expected values

According to Lee (2013, p.217), “the mean (central location) of a random variable is called the
expected value and is denoted by E(X).”

𝐸 𝑋 = ෍ 𝑋𝑖 𝑃(𝑋𝑖 )
𝑖=1

Expected value is a weighted average of all possible outcomes. It is that the value of each possible
outcome, Xi, multiplies the probability of that outcome, p(Xi), and then sum up all the results.

When having a number of alternative choices, the one with highest expected value should be the
best choice. It is also a useful method for risk neutral decision maker as a risk neutral investor
happy to accept an average outcome

37
 5.1.3 Normal distribution
According to Lee (2013), the most widely used continuous density distribution in statistics is
normal distribution. Characteristics of a normal distribution are:
(a) the distribution is centered on its mean
(b) the distribution is symmetric, therefore
(c) the mean and median also occur at the same point, and
(d) the bell-shaped normal curve has a single peak

Figure 5-2 38
 5.1.3 Normal distribution

Regardless of the values 𝜇 and σ^2 of the normal probability distribution, the total areas
under the probability density function are the sum of the probabilities of each possible
outcome, i.e., 1.

Standard normal distribution

The standard normal distribution is the normal distribution with a mean of 0 and a
standard deviation of 1.

To find the area under the normal curve between the mean and a point Z standard
deviations above the mean, use the table below. The corresponding site for a point Z
standard deviation below the mean can be found using symmetry.

39
5.1.3 Normal distribution
Table 5-6

40
5.1.3 Normal distribution

41
5.2 Sampling Methods

Non-probability based
Probability based sampling
sampling

Random sampling Quota sampling

Stratified random
sampling

Cluster sampling

Multistage sampling

Systematic sampling
Table 5-7
42
Chapter 6
Forecasting
 6.1 Correlation analysis

Correlation analysis is a group of techniques to measure the association between two variables
and indicate the direction and strength of the relationship between the two variables.

Note: Two variables are related if the value of one variable changes as the value of the other
variable changes.

Generally speaking, to study the correlation of two variables, the first step is to draw the scatter
diagram. And now, it is necessary to distinguish independent variables from dependent
variables. The independent variable is the basis of prediction, as the cause of change of the
dependent variable, and the dependent variable is the value that needs to be predicted. That is,
the X value indicates the Y value.

44
 6.1 Correlation analysis
Direction of correlation
Positive correlation Negative correlation
Two related variables move in the same When two related variables change in
direction, and this correlation is called a opposite directions, this correlation is
positive one. called a negative correlation.

4.5 Y 8
Y
4 7
3.5 6
3 5
2.5
4
2
3
1.5
2
1
0.5 1

0
X 0 X
0 1 2 3 4 5 0 2 4 6 8 10
Figure 6-1 Figure 6-2 45
 6.1 Correlation analysis
Strength of correlation

Perfect correlation
Perfect correlation means that if you plot points on a scatter plot, all points
can be connected by a straight line.
Y Y
4.5 4.5
4 4
3.5 3.5
3 3
2.5 2.5
2 2
1.5 1.5
1 1

0.5 X 0.5 X
0 0
0 1 2 3 4 5 0 1 2 3 4 5
Figure 6-3 Figure 6-4 46
 6.1 Correlation analysis
Strength of correlation

Partial correlation
Although not entirely linear, the value of X tends to change in the same direction as
Y's (partially positive correlation). The value of X tends to change in the opposite
direction as the value of Y (somewhat negative correlation).
Y Y
4.5 5
4 4.5
3.5 4
3.5
3
3
2.5
2.5
2
2
1.5
1.5
1 1
0.5 X 0.5 X
0 0
0 1 2 3 4 5 0 1 2 3 4 5 47
Figure 6-5 Figure 6-6
 6.1 Correlation analysis

Strength of correlation

No correlation/uncorrelated
The values of the two variables are not correlated.

4.5
Y
4
3.5
3
2.5
2
1.5
1
0.5
X
0 Figure 6-7
0 2 4 6 8 10 48
 6.1.1 Coefficient of correlation

The coefficient of correlation, r measures strength of linear correlation between two variables.

For two variables X and Y, the coefficient of correlation, r, is positive if the Y increases with X;
negative if the Y is decreasing with X.

• r = +1 means that the variables are perfectly positively correlated.

• r = –1 means that the variables are perfectly negatively correlated.
• r = 0 means that the variables are uncorrelated.

Note: r is one of the coefficients used to measure the strength of linear correlation, and its
value is between -1 and 1. The closer the absolute value of r is to 0, the weaker the linear
correlation is. The closer it gets to 1, the stronger the linear correlation. 49
 6.1.2 Coefficient of determination, 𝑟 𝟐

The coefficient of determination, 𝑟 2 (alternatively 𝑅2 ) indicates “the proportion of the total

variation in the dependent variable Y that is explained, or accounted for, by the variation in the
independent variable X”. (Lind, 2006, p.381)

Similar to the coefficient of correlation, the coefficient of determination can be used to show
the degree of correlation between two variables, but it is usually expressed as a percentage.

For example, if the correlation coefficient (r) between a company’s promotion costs and sales
revenue was 0.85, 𝑟 2 would be 0.7225, meaning that 72% of variations in sales revenue could
be explained by variations in promotion cost, leaving 28% of variations to be explained by
other factors (such as economic affluence).

50
 6.1.3 Correlation and causation

A correlation between two variables does not imply that the variation in one causes the variation
in the other.

If there is a strong relationship between two variables, we assume that an increase or decrease in
one leads to a change in the other. This assumption is incorrect. For example, there is a solid
seasonal correlation between sales of watermelons and sales of electric fans. However, this does
not mean that increased consumption of watermelons has led to increased consumption of electric
fans. This relationship is called spurious correlation. When we find a strong correlation between
two variables, we can conclude a statistical relationship or association between the two variables,
rather than a change in one leading to a change in the other.

The more data collected, the less likely it is that a spurious correlation will appear, but the
possibility can never be removed.

51
 6.2 Regression analysis

Now, we try to establish an equation to represent a linear (straight) relationship between

two variables. In addition, we want to be able to estimate the value of the dependent
variable y from the selected value of the independent variable x. The technique used to set
up equations and find estimates is called regression analysis.

The equation of a line that estimates the y value from the x value is called the regression
equation.

Methods for identifying the linear relationship.

• High-low method (see chapter 3).
• Least square method - the "best-fitting" line

52
 6.2.1 Least squares method

Least Squares Principle

“Determining a regression equation by minimizing the sum of the squares of the vertical
distances between the actual Y values and the predicted values of Y.” (Lind, 2006, p.387)
In ACCA MA exam, the least squares method of linear regression analysis involves using the
following formula:

The formula will be given in the exam. Y=a+bx is the equation of “the line of best fit” using
least squares method, and it will be used as the prediction line.

53
 6.3 Time series

6.3.1 Principles of time series analysis

A time series is a set of numerical data collected over time.

Time-series forecasting assumes that the factors that have influenced activities in the past and
present will continue to do so in approximately the same way in the future. Time series
forecasting seeks to identify and isolate these component factors in order to make predictions.

54
 6.3 Time series

6.3.1 Principles of time series analysis

The variation in a time series can be broken down into four categories:

• Trend: are potential long-term changes in recorded data values over a period of time.

• Seasonal variations: it refers to the regular variations which exist within the data. This
could be a weekly variation with certain days traditionally experiencing higher or lower
sales than other days, or it could be monthly or quarterly variations.

• Cyclical variations : fluctuations which take place over a longer time period than seasonal
variations. It may take several years to complete the cycle.

• Random variations: these are other unpredictable variations.

55
 6.3.2 Moving averages, trend and seasonal variation

When you look at the year-to-year data, your visual impression of long-term trends in the series
can sometimes be obscured by the amount of change from year to year. Often, you can't tell if
there's a long-term upward or downward trend in the series. To better understand the overall
pattern of data changes over time, moving averages method can be applied.

Figure 6-10 56
 6.3.2 Moving averages, trend and seasonal variation

In simplicity, we just assume that there are only seasonal variations and trend included in the
total variation of the time series. There are two types of seasonal variations: additive model
and multiplicative model

In an additive model, the difference between the actual figures and the trend is an additive
difference. The sum of seasonal differences over a period is 0. Y=T+S

In the multiplication model, the actual number is a specific proportion of the trend, and that
proportion is the multiplicative difference. Y=T*S

57
 6.3.3 Deseasonalisation（Derive seasonally adjusted data）

Lecture illustration
The actual sales figures for the four quarters and the appropriate seasonal adjustments for the
previous year are as follows:
Table 6-10

Seasonal
Quarter Actual price
variations
$ $
1 30 +6
2 32 +8
3 38 -4
4 34 -10

Required:
Calculate seasonally adjusted data.

58
 6.4 Index

Index numbers measure the value of an item (or group of items) at a particular point in time as a
percentage of the value of an item (or group of items) at another point in time.

Current period′s figure

Index = ×100
Base Period figure

a) A price index measures the change in the money value of an item or a group of items over time.

b) A quantity index (also called a volume index) measures the change in the non-monetary
values of an item or a group of items over time.

59
 6.4.1 Simple index numbersx

In its simplest form, an index is simply a percentage used to represent the relationship between
two numbers, calculated using one of the numbers as a base. For example, in a time series of
particular commodity prices, we can express prices as percentages, dividing each price by the
base price. These percentages are called relative prices, or indices.

Simple indices can be divided into price index and quantity index. Formula is as follows:
𝑃𝑛
Price index = × 100
𝑃0
Where 𝑃𝑛 is the price in the current period and 𝑃0 is the price in the base period.

𝑄𝑛
Quantity index = × 100
𝑄0
Where 𝑄𝑛 is the quantity in the current period and 𝑄0 is the quantity in the base period.

60
 6.4.2 Fixed-base & Chain-base index

Fixed base index: “In a time series, an index number whose base period for computing
the index number is constant throughout the lifetime of the index.” ("fixed-base index")

Chain base index: “An index number in which the value of any given period is related
to the value of its immediately preceding period.” ("Glossary:Chain index")

61
 6.4.3 Composite index numbers

2. Weighted/multi-item aggregate index

There are different methods to calculate the weighted index, and the following three are
introduced: Laspeyre index, Paasche Index, and Fisher's Index.

62
Part C
Cost accounting techniques
Chapter 7
Accounting for material

64
 7.1 Inventory control process
Inventory control includes:
(a) control of the process
(b) control of inventory quantities

The inventory control should cover all the processes:

• The ordering of inventory
• The purchase of inventory
• The receipt of goods into store
• Storage
• The issue of inventory

Ordering Purchasing Receiving Storage Issuing

65
7.1.1 Documentation

Figure 7-1

66
 7.1.1 Documentation

Other records

Materials transfer note: materials transfer from user department A to user department
B without being return to stores.

Materials returned note: materials are returned to stores. Transfers between different
categories of inventory.

Goods despatch notes: issued by stores, resulting from a sale of items of finished goods.

Inventory master file: a list of all inventories that have ever exist in the company.

67
 7.2.1.1 Reorder level

The re-order level is the point at which the buying department places its order for
replacement materials.

Note: When the inventory in the warehouse is reduced to the quantity that needs to be
reordered, in order to avoid the problem of shortage, the company needs to place orders to
suppliers. The level of reorder depends on two factors: maximum consumption and maximum
delivery time.

Reorder level= maximum usage × maximum lead time

The lead time is the time between placing an order with a supplier, and the inventory
becoming available for use.

68
 7.2.1.2 Minimum level and Maximum level

Many businesses have minimum and maximum levels in their inventory systems. Minimum
and maximum inventory levels provide "warning flags" for management. Inventory levels
should be no lower than the minimum and higher than the maximum.
The maximum level is the uppermost level that the buying department should not exceed.
Beyond this level, it may be necessary to recruit additional warehouse staff or rent additional
storage space, and carrying costs become unacceptable.
The minimum level is the lowest level that allows the activity of the organisation to be
maintained.
It is also called buffer stock or safety stock. Enterprises need to hold a certain level of safety
inventory to prevent sudden supply interruption and lead to production. In general, the safety
stock cannot be zero.
The commonly used calculation method is：
Minimum level= reorder level – (average usage × average lead time)
Maximum level = reorder level + reorder quantity – (minimum usage × minimum lead time)
69
 7.2.1.3 Free inventory

Free inventory represents what is really available for future use.

Materials in inventory X
+ Materials on order from suppliers X
– Materials requisitioned, not yet issued (X)
Free inventory balance X

For example, a company has 100 tons of raw materials in its warehouse and has
ordered another 20 tons of raw materials from a supplier, but it is still on delivery.
Meanwhile, a sales order needs 30 tons of raw materials, but it has not been sent out
from the warehouse. Then, the available stock of this raw material should be: 100+20-
30=90 (tons)
70
 7.2.2 Reorder quantities
To decide how many quantities to reorder each time, the costs of inventory should be taken
into consideration. The aim is to minimize the total cost associating with inventory.
Costs associated to inventory:
P = purchase price
D = annual demand in units
C = cost per order
O

CH = holding cost per unit for one year

Q = number of units ordered
Ⅰ. Purchase costs: consist of the costs of goods acquired from suppliers.
• purchase price
• unaffected by stock policy unless bulk discounts are available
• Total annual purchase costs = purchase price × annual demand in units
=P×D
71
 7.2.2.1 Costs associated to inventory
Ⅱ. Holding costs: arise when a business holds stocks of goods for sale, and may include:
• Depreciation
• Insurance
• Obsolete inventory write-offs
• Personnel
• Rental space
• Security

• Total annual holding cost = holding cost per unit ×average inventory

Q
= CH×( + minimum inventory)
2

Q
• Average inventory = + minimum inventory
2
72
 7.2.2.1 Costs associated to inventory

Ⅲ. Ordering costs: consist of the costs of preparing and issuing a purchase order.
• Transport
• Administrative
• Production run （number of orders）
• Total annual ordering cost = cost per order × number of orders pa
D
= CO ×
Q
Ⅳ. Stock out costs: occurs when a company runs out of a particular item for which there is
customer demand.

Note: If there is a shortage of raw materials needed for production, production will be shut
down, resulting in the company can not deliver goods on time, losing orders. Moreover, it may
cause some unquantifiable losses, such as the impact on the company's reputation and brand
image.
73
 7.2.2.2 Economic order quantity (EOQ)
The economic order quantity (EOQ) decision model calculates the optimal quantity of stock
to order.
The simplest version of this model incorporates only ordering costs and carrying costs into
the calculation.

Annual costs Total costs

($)
Holding costs

2Co D
EOQ = (given in exam)
CH

Ordering costs
Figure 7-3
EOQ Quantity
74
 7.2.2.4 Economic batch quantity (EBQ)

EBQ is primarily concerned with determining the number of items that should be produced in
a batch.

R = production rate or delivery per time period

Q = batch size
D = the usage per time period
C = the set up cost per batch
O

C = the holding cost per unit of inventory per time period

H

75
 7.3.2 Inventory valuation under perpetual system

The most commonly used inventory valuation methods are:

* FIFO. (first in, first out)

* LIFO. (last in, first out)
* AVCO (average cost) or WACO (weighted average cost)

76
Lecture Example 7

MATERIAL CONTROL ACCOUNT

DR $ CR $

77
Chapter 8
Accounting for Labour
 8.1.1 Timework

• Basic
• Wages = Time worked × Rate
• Time can be hour, day, week or month
i.e. Wages = Hours worked × Rate of pay per hour

• Overtime premium
• Overtime is often paid at a basic rate plus an extra amount for incentive.
• The extra rate per hour paid for overtime is called overtime premium.

For example, if an employee works overtime and is paid 1.5 times the hourly rate,
then the overtime premium is paid 0.5 times the hourly rate for working longer
hours.

79
 8.1.1 Timework

Advantages and disadvantages of timework system

• Easy to calculate and manageable.
• The output will be focused on quality rather than quantity.
• Lead to low efficiency.
• The motivation of employees could not be increased.

80
 8.1.2 Piece work

Wages = Units produced × Rate of pay per unit.

A guaranteed minimum wage:

It refers to the minimum labour remuneration that the company should pay if the
piecework workers provide normal labour within the working hours agreed in the
labour contract. Therefore, piecework workers will not suffer the loss of wage
income due to the low output of their products. For example, the company's main
products are seasonal products, which will cause output fluctuations due to seasonal
factors. Piecework workers will not get lower wages due to low output in the off-
season.

81
 8.1.2 Piece work

Differential piecework schemes: These offer an incentive to employees to increase their

output by paying higher rates for increased levels of production.

Advantages and disadvantages of piecework system

• Increase the motivation of workers
• Improve the workers’ performance to earn satisfactory earnings
• Lead to ignore the quality of outputs

82
 8.1.3 Bonus/incentives schemes

(a) Reasons for bonus

• Encourage employees to create more value
• An effective bonus scheme can improve employees’ performance
• Reduce labour turnover rate

83
 8.1.3 Bonus/incentives schemes

(b) The incentives can be paid according to the performance of an individual or a group of
employees.
• Individual incentive schemes: reward systems tied to the performance of individual
employees are known as personal incentive schemes.

• Group incentive schemes: bonus is calculated on the collective production of a group of

interdependent workers and distributed among group members on some agreed terms and
conditions.
For example, when assessing the performance of a sales team, each member of the sales team
will strive to achieve the best version of the whole team. At this time, it is difficult to measure
the contribution of each member, so it is more suitable for group incentive schemes.

(c)There are many ways of deciding how much to pay as a bonus.

Most bonuses are delivered on time saved in comparing with the standard time

84
8.2.2 Labour efficiency, capacity and production volume ratios

85
 8.2.3 Idle time

Idle time is non-productive time (during which an employee is still paid) of employees or
machines, or both, due to work stoppage from any cause.

Note: Idle time has a cost because employees will still be paid their basic salary during
these unproductive hours, so recording idle time and reducing it can be an effective way
to improve business performance.

Total time =Idle time + Productive time

86
 8.2.4 Labour turnover

Labour turnover refers to the rate at which employees leave a company and are replaced by
new employees.

I. Calculation

Note: Number of replacements refers to the number of employees replaced over a period of
time. For example, 10 employees left and 20 joined during the same period, resulting in 10
employees being replaced.

87
 8.2.4 Labour turnover

Ⅱ. costs

There are two types of costs associate with turnover

(a) Replacement costs

• Cost of selection and placement
• Inefficiency of new labour
• Costs of training

(b) Preventative costs

• Cost of personnel administration incurred in maintaining good relationships
• Cost of welfare services, including sports facilities and canteen meals

88
 8.3 Direct and indirect cost

Direct workers Indirect workers

Normal basic pay Direct cost Indirect cost
Overtime – basic pay
General production Direct cost Indirect cost
element
Overtime premium Indirect cost Indirect cost
Overtime – basic pay
Specific request from Direct cost Direct cost
element
customer
Overtime premium Direct cost Direct cost
Allowance, sick pay, idle
time, bonus, NIC (national
Others Indirect cost Indirect cost
insurance contribution),
general non-production

89
8.4 Recording labour cost in accounts

90
Chapter 9
Accounting for overhead
9.2 Process
Total production cost

Direct cost Indirect cost

1. Allocation
Production Production Service General
A B Dept. cost centre

2. Apportionment
Production Production Service
A B Dept.

3. Re-apportionment

Production Production
A B
4. Absorption

Cost unit

Figure 9 - 2 Process of absorption costing

 9.2 Process

Production 1 Production 2 Service 1 Service 2

9.2 Process

Step1
Allocation

Step2 Direct method

Apportionment

Step3 Step down method

Re-apportionment
Reciprocal method
Step4
Absorption
Algebraic

Figure 9 - 3 Process of Allocation

9.2 Process

Methods

Direct Step down Reciprocal Algebraic

method method method method

Inter-service Some inter- All inter-service Reciprocal

department service department work is concept,
work is ignored department recognised done by
or there is no work is (sometimes called algebraic
inter-service recognised the repeated approach
work distribution method)

Figure 9 - 4 Methods of Re-apportionment

 9.3 Over/Under absorption

9.3.1 Pre-determined overhead absorption rates (OAR)

Businesses need to cost their production throughout the year, not at the end of an accounting
period. Therefore, they predetermine or estimate their absorption rates for the year.

Budgeted production overheads

Per-determined OAR =
Budgeted level of activity

Note: the activity level is production volume rather than sales volume.

Using a pre-determined OAR avoids fluctuations in unit costs caused by abnormally high or
low overhead expenditure or activity levels, and offers the administrative convenience of being
able to record full production costs sooner.
 9.3 Over/Under absorption

Time 0 Time 1 Time 2

Production…
➢ Set the Budget ➢ Actual activity level √ ➢ Actual overhead √
Inventory valuation Absorption Actual ≠ Absorbed
& Unknown overhead → Over / under absorption
Overhead absorbed
Predetermined OAR =
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑂𝐻 = Actual activity level
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑙𝑒𝑣𝑒𝑙 × pre-determined OAR
 9.3 Over/Under absorption

9.3.2 Absorption into production

Absorbed overhead = (pre-determined) OAR × actual activity level

The rate of overhead absorption is based on estimates and it is quite likely that either one or
both of the estimates will not agree with what actually occurs.

End of the year: actual overheads will be known, and it is likely that
Overhead Absorbed ≠ Actual Overhead

Over absorption (over recovery of overheads) occurs when the allocated amount of overhead
costs in an accounting period exceeds the actual (incurred) amount in that period.

Under absorption (under recovery of overheads) occurs when the allocated amount of
overhead costs in an accounting period is less than the actual (incurred) amount in that period.
The AC approach

Cost 1
OAR 1
Fixed
Cost 2 Production OAR Product
Overhead
OAR 3
Cost 3
The ABC approach

Cost Pool 1 Cost Driver 1

OAR 1

Cost Pool 2 Cost Driver 2 OAR 2 Product

OAR 3
Cost Pool 3 Cost Driver 3
Chapter 10
Absorption and marginal costing
Absorption costing
Direct material
Sales X Direct labor
Less: COS (full pro costs) (X) Variable pro OH
Gross profit X Fixed production OH
Less: Non-production costs (X) Adjustment of over / under absorption
Net profit X

Marginal costing
Direct material
Sales X Variable production costs Direct labor
Less: ALL Variable costs (X) Variable pro OH
Contribution X Variable non-production costs
Less: Fixed costs (X)
Net profit X
 Reconciling profit

公式：

Difference in profits = change in inventory level × overhead absorption rate per unit

If closing inventory > opening inventory,

then absorption costing profit > marginal costing profit.
AC会将一部分fixed overhead藏在closing inventory中带到下一期

If closing inventory < opening inventory,

then absorption costing profit < marginal costing profit.
AC会将上一期藏在inventory中的fixed overhead在当期作为COS减去
Chapter 11
Process costing
 11.1 Basics of process costing

11.1.1 Introduction
Special process costing techniques are required where there is a continuous flow of
production of similar units of output. This situation of a continuous process arises in the
chemical industry and in other industries such as textiles, paint, food, steel, glass, mining,
cement and oil.

Specifically, the process costing system classifies costs according to the time of the cost
introduced into the process. Usually, there are only two types of costs that need to be
allocated to the product, namely direct materials and conversion costs.

Conversion costs are all manufacturing costs other than direct material costs. These include
manufacturing labour, indirect materials, energy, plant depreciation, and so on.
11.1.2 Process costing with no opening or closing work-in-progress or losses
 11.1.2 Process costing with no opening or closing work-in-progress or losses

Recording…
 11.2 Valuing WIP

Definition

An equivalent unit of output is the amount of output, expressed in terms of whole units,
which is equivalent to the actual amount of partly or fully completed production.

Equivalent units = units of WIP × degree of completion

 11.2.1 Process costing with closing WIP (no opening WIP)

Three steps to calculate the cost of completed units and WIP

Step 1. Compute output in terms of equivalent units.
Step 2. Compute costs of equivalent unit.
Step 3. Assign total costs to units completed and to units in closing WIP.

And finally, record results in T accounts.

11.2.1 Process costing with closing WIP (no opening WIP)
 11.2.2 Valuing closing WIP (with opening WIP) - FIFO

1. The weighted-average process costing method calculates the equivalent-unit cost of the work
done to date (regardless of the period in which it was done) and assigns this cost to equivalent
units completed and transferred out of the process and to equivalent units in closing work-in-
progress stock. * 把上一期的cost和unit都当做本期发生，从0%做到100%

2. In contrast to the weighted-average method, the first-in, first-out (FIFO) process costing
method assigns the cost of the previous period’s equivalent units in opening work-in-progress
stock to the first units completed and transferred out of the process, and assigns the cost of
equivalent units worked on during the current period first to complete beginning stock, then to
start and complete new units, and finally to units in closing work-in-progress stock. This method
assumes that the earliest equivalent units in the Work in Progress – Assembly account are
completed first.
* 先完成上一期未完成的部分再生产当期
 11.3 Dealing with losses

11.3.1 Introduction of losses in process costing

Good output

Input Process A Normal loss Expected

Abnormal loss
Or NOT
Abnormal gain expected

Figure 11-1 losses in process costing

 11.3.1 Introduction of losses in process costing

Accounting for process losses:

Rule 1: expected output from a manufacturing process is the amount of the input less the normal
loss. expected output = input - normal loss

Rule 2: abnormal loss or gain in a process is the actual output less the expected output. If actual
output is less than expected output an abnormal loss occurs. If actual output exceeds expected
output an abnormal gain occurs.

Rule 3: normal loss is not allocated a share of process costs in the process account. Total costs
are allocated to the expected output (via actual output and abnormal loss or gain) – i.e. cost per
unit for a period is total cost divided by expected output.
 11.3.1 Introduction of losses in process costing

Rule 4: abnormal loss or gain is allocated a share of process costs in the process account. This is
necessary so as to clearly identify the cost/benefit and to reconcile the process account.

Abnormal loss (a cost) is credited to the process account: abnormal gain (a benefit) is debited to
the process account.
Abnormal loss： Dr Abnormal loss, Cr Process account
Abnormal gain： Dr Process account, Cr Abnormal gain

The equal and opposite entry is in the abnormal loss/gain account, subsequently transferred to
the income statement.
Abnormal loss：Dr Income statement, Cr Abnormal loss
Abnormal gain：Dr Abnormal gain, Cr Income statement

*Abnormal loss or gain的价值与good unit相同，即最初计算出的cost per unit.

 11.3.1 Introduction of losses in process costing

Rule 5: losses may have a scrap value. Revenue from scrap sales is treated as a reduction in costs. The
scrap value of normal loss is credited to the process account and is offset against the process costs in the
calculation of cost per unit. The scrap value of abnormal loss/gain is credited/debited respectively in the
abnormal loss/gain account to reduce the cost/benefit of abnormal loss/gain.

* Normal loss的残值：抵消process cost

Abnormal gain/loss的残值：在自己的账户里进行抵消处理
 11.4 Joint products and by-products

11.4.1 Definition

Joint products are two or more products arising from a process, each of which has a
significant sales value.
A by-product is a product arising from a process where the sales value is insignificant by
comparison with that of the main product or products.
Joint costs are thus the costs of a production process that yields multiple products
simultaneously.
The juncture in the process when one or more products in a joint-cost setting become
separately identifiable is called the split-off point.
 11.4.2 Allocating joint costs

Generally speaking, there are two approaches to allocating joint costs/common costs:

1) Sales value at split-off method

This method is to allocate the common cost to each product according to the sales value of
the production volume of various products at the split-off point (the production volume×
the selling price per unit).
2) Physical measure-based method
This method is to allocate the common cost to various products according to the physical
quantity ratio of various products at the split-off point.
 Lecture illustration 4

• By-product sales revenue is credited to the common costs account

→ deducted from common cost 抵消共同成本

• By-product sales revenue is credited to the sales account

→ recognized as other income (no influence on common costs)
单独确认为收入，不影响成本
Chapter 12
Alternative costing methods
 12.1 Job costing

12.1.1 Definition

“A job-costing system is a system of cost accumulation where there is an identifiable activity

for which costs may be collected. The activity is usually specified in terms of a job of work or a
group of tasks contributing to a stage in the production or service process.” (Weetman, 2010,
p.129)

In manufacturing, a batch or order can be used as a single unit, such as a set of houses to be built.
Generally speaking, each batch is associated with a specific customer order. For each batch or
order, because its main feature is that each batch has a different cost, it must be accounted for
separately.
 12.1.2 Job pricing---Margin & Mark-up

Margin = profit/sales
Mark-up = profit/costs

Companies use margin and mark-up to determine a job price. For example:
• A selling price based on a 10% margin:
cost of job (90%)+profit (10%)=selling price (100%)
• A selling price based on a 10% mark-up:
cost of job (100%)+profit (10%)=selling price (110%)
 12.2 Batch costing

Definition

“Batch costing is a blend of job-order and process-costing procedures applied to batches of

homogeneous products. This costing system uses job-order procedures to assign direct
materials costs to batches and process procedures to assign conversion costs.” (Hansen, 2007,
p.188）
 12.3 Service costing

According to institute of cost and management accountants, operating costing applied where
standardised services are provides by an undertaking or by the service cost center within
undertaking.
The cost unit is usually a composite figure, such as ton-kilometers, kilowatt-hours, patients-
day, etc. The cost calculation should be comprehensive enough to show the impact of off-
season and peak-season demand, full-time and part-time.
Service cost units can be divided into single cost unit and composite cost unit:
Single cost unit is made by single element, such as per day, per night and per patient.
Composite cost unit is made by two or more elements. For example: per passenger km, per
patient day, and per occupied room night.

Total costs for period

Cost per service unit =
Number of service units in the period
 12.4 Life cycle costing

Definition
According to Bhimani (2015, p.394), “the product life cycle spans the time from initial R&D to
the time at which support to customers is withdrawn” and “Life-cycle costing tracks and
accumulates the actual costs attributable to each product from start to finish.”
 12.4 Life cycle costing

A product life cycle can be divided into:

a) Development（研发期）
b) Introduction（导入期）
c) Growth（成长期）
d) Maturity（成熟期）
e) Decline（衰退期）
 12.5 Target costing

‘A target cost is the difference between the sales price needed to capture a predetermined market
share and the desired per-unit profit.’(Hansen, 2007, p.393).
Atrill (2009, p.151) suggested that target costing can be implemented through the following steps:
1) First, with the help of market research or other means, a unit selling price and sales volume are
established.
2) From the unit selling price is taken an amount for profit. This unit profit figure must be such as
to be acceptable to meet the business’s profit objective.
3) The resulting figure is the target cost.
Target cost = target selling price – target profit
4) The target cost may well be less than the ‘current’ cost (estimated cost).
5) There may be a ‘cost gap’ = estimated cost – target cost
6) Efforts are then made to bridge this gap, that is, to provide the service or make the product in
such a way as to enable the target cost to be met.”
 12.5 Target costing

Hansen (2007) argued that there are three cost reduction methods are typically used:

(1) Reverse engineering: a careful analysis ("disassembly" analysis) of competitors' products is

performed in an attempt to discover more design features that can reduce costs.

(2) Value analysis: Value analysis attempts to evaluate the value of various product functions by
customers (there are four types of value, namely cost value, exchange value, use value, esteem
value). If the customer is willing to pay a price lower than its cost for a particular feature, the
feature can be eliminated. Another possibility is to find a way to reduce the cost of providing the
function, such as using common components, but the premise is that the value of the product or
function to the customer (perceived value) cannot be reduced.

The difference between value analysis and value engineering:

Value analysis: refers to the analysis of existing products so as to reduce their costs.
Value engineering: refers to setting the cost of a new product to the lowest when it is designed.
 12.5 Target costing

(3) Process improvement: The process used to produce and sell products is also a source of
potential cost reduction. Therefore, redesigning the process to improve efficiency also helps to
achieve the required cost reduction.
 12.6 Total quality management

Definition

‘A philosophy of total quality management, in which managers strive to create an environment

that will enable firms to produce defect-free products and services, has replaced the
acceptable-quality attitudes of the past.’ (Hansen, 2007, p.10)

As customers pay more attention to the improvement of product quality, companies have to
optimise product quality to meet customer needs. Companies often use two ways to improve
product quality:
• Prevent problems from occurring;
• Solve problems immediately when they occur.
 12.6 Total quality management

Quality cost can be divided into four categories:

1) Prevention cost: These are involved with procedures to try to prevent items being produced
that are not up to the required quality. (e.g.: training cost)
2) Appraisal cost: These are concerned with monitoring raw materials, work in progress and
finished products to try to avoid substandard products from reaching the customer. (e.g.: testing
cost)
3) Internal failure costs: These include the costs of rectifying substandard products before they
pass to the customer and the costs of scrap arising from quality failures. (e.g.: rework cost of
substandard products)
4) External failure costs: These are involved with rectifying quality problems with products
that have passed to the customer. (e.g.: recall cost of substandard products)
Part D Budgeting
Chapter 13
Nature of budgeting and
budget preparation
 13.1.2.1 Budget committee and budget manual

Budget committee “generally includes the chief executive officer, the chief operating officer,
and the senior executive vice president. The composition of the budget committee reflects
the role of the budget as the planning document that reflects and relates to the organisation’s
strategy and objectives.” (Atkinson, 2011, p.434)

A budget manual is a set of instructions used by large organizations to prepare budgets.

(Kenton, 2019)

The budget manual aims to provide every employee in the organization with all
information related to the budget and avoid misunderstanding as much as possible.
Generally speaking, the budget is prepared according to the organizational objectives
given in the budget manual. Managers' responsibilities in budgeting are also clearly
listed in the budget manual to avoid overlapping responsibilities as much as possible.
 13.1.2.2 Role of accountant in budgeting process

• Will have the computer facilities to prepare and coordinate the budget process.
• Will work with operations managers to prepare budgets and advise and assist in
the practical aspects of budget preparation.
• Must involve themselves with the operations team in the budget exercise and
understand the commercial issues.
• Offer challenges to the operations managers, but such challenges will be aimed at
ensuring improved budgets for the benefit of the whole organisation and the
operational unit.
 13.1.3 Negotiate budgets with line managers

There are generally two methods of budgeting: top-down budget (imposed

budget) and bottom-up budget (participative budget).

Many writers refer to the third form of budgeting (negotiated budgeting), which
combines the above two methods. The person in charge of budgeting and the
management can determine the budget objectives through negotiation.
 13.1.3 Negotiate budgets with line managers
Comparison Table for Bottom-up budget and Top-down budget
Bottom-up budget Top-down budget
1. the budgets are consistent with
strategies
1. more motivation due to more
2. senior managers have a better
participation
knowledge of total resources
2. more commitment from
Advantages available
managers
3. The input of inexperienced or
3. More detailed information is
low level employees is
taken into account
decreased.
4. Budgeting process is faster
1. senior managers lose control of 1. junior employees may be
the company dissatisfied
2. the budgets may conflict with 2. junior employees are
Disadvantages strategic objectives demotivated
3. it takes much longer to finish a 3. be lack of team spirit
budget 4. the recognition of strategic
4. Too easy targets will be set objectives is limited
 13.1.3 Negotiate budgets with line managers

Budgetary slack is the deliberate under-estimation of budgeted revenue or over-estimation

of budgeted expense. (Bragg, 2017)

When managers' performance evaluation and bonus are linked to budget figures, it is
likely to promote managers to better "make the numbers they want". At this time, it
is easier to have budget slack.

If there is considerable uncertainty about the expected results in the future, in this
case, managers tend to be more conservative when formulating budgets.
Especially when creating a budget for a new product line, there may be budget slack
because there is no historical data to refer to.
When companies use participatory budgeting, budget slack is the most common. In
this budget model, a large number of employees will be involved, which makes more
people have the opportunity to incorporate budget slack into the budget.
 13.2 The master budget

Operating budget

An example of master budget

Financial
budget
13.2.1 Sales budgets and functional budgets
Sales budget

Finished inventory budget

Budgeted production
= budgeted sales
Production budget
+ closing inventory
– opening inventory
Material usage budget
Budgeted material purchase
= material usage
Material purchase budget
+ closing inventory
– opening inventory
Labour budget

Overhead budget
 13.2.2 Cash budget

Definition

The cash budget is the detailed plan that shows all expected sources and uses of cash.
(Hansen, 2007, p.261)

Note: cash budget is the summary of related budgets of cash inflow and outflow.

Cash flow is critical to the company's operations. Enterprises can succeed in

producing and selling products, but it is likely to lead to business failure due to
the time difference of cash inflow and outflow. This requires enterprises to master
the cash flow situation and understand when there will be cash shortage or
surplus. As cash flow is the lifeblood of an enterprise, cash budget is one of the
most important budgets in the total budget.
 13.2.2 Cash budget

• Gross Profit
Sales – Cost of sales = Gross Profit
Gross Profit = Sales – Cost of sales

• Operational cash flow

Cash in – Cash out = Operational cash flow

Note: Profit is calculated by applying the matching concept, that is, matching the costs
incurred with the sales revenue generated during the period.
 13.2.2 Cash budget

Net cash flow: the net cash flow is obtained by calculating the difference between the cash received
(inflow) from the bank account and the cash paid (outflow) from the bank account.
Operational cash flow = Cash in – Cash out

Notes
Cash in = Sales + Opening receivables – Closing receivables
Purchases = Cost of sales + Closing inventory – Opening inventory
Cash out = Purchases + Opening payables – Closing payables
Chapter 14
Flexible budgets and budgetary control
 14.1 Fixed budgets and flexible budgets

14.1.1 Fixed budgets

“A fixed budget is one that is based on one level of output; it is not usually changed after it is
agreed. The fixed budget is used for planning purposes. The budgeted profit and loss account,
budgeted balance sheet and cash budget constitute the highest level of fixed budgets and
together may be termed the master budget.”(Coombs, Jenkins & Hobbs, 2005, p.512).

A fixed budget is a budget formulated at the beginning of a budget period based on the planned
output level of that period. Although the fixed budget amount is crucial to the plan, it is not
useful for control. The reason is that the expected level of activity is rarely equal to the actual
level of activity. Therefore, the costs and revenues of expected activity levels cannot be easily
compared with the actual costs and revenues of different activity levels.
 14.1.1 Fixed budgets Flexible budgets and budgetary control

Comparing budgets with actual results, a favourable variance (denoted F) is a variance that
increases operating income relative to the budgeted amount. An unfavourable variance (denoted
U) is a variance that decreases operating income relative to the budgeted amount. (Bhimani, 2015,
p.509)

Note: the favourable variable is the difference favourable to the profit. Unfavourable variance
also known as the adverse variance (denoted A), is the difference unfavourable to the profit. In
ACCA test, the difference unfavourable to profit is uniformly denoted as A.
 14.1.2 Flexible budget
Flexible budgets and budgetary control

The budget that (1) provides expected costs for a range of activity or (2) provides budgeted
costs for the actual level of activity is called a flexible budget. (Hansen, 2007, p.268)

Flexible budget has two main benefits:

• They allow companies to predict outcomes at different levels of activity. If the company is
uncertain about some key issues, such as potential sales this year, it is useful to use a
flexible budget.
• After determining the actual cost in a specific period, flexible budget can be used for
feedback control. If the actual cost of a period is compared with the flexible budget rather
than the fixed budget of the period, valuable control information can be obtained.
 14.1.2 Flexible budget
Flexible production budget
Range of Sales (units)
Sales price/Variable cost per unit
3,000 3,500 4,000
Sales revenue $20.00 $60,000 $70,000 $80,000
Production costs:
Variable :
Direct materials $3.00 $9,000 $10,500 $12,000
Direct labour $2.50 $7,500 $8,750 $10,000
Variable overhead
Indirect labour $2.00 $6,000 $7,000 $8,000
Power $0.50 $1,500 $1,750 $2,000
Supplies $0.80 $2,400 $2,800 $3,200
Total variable cost $8.80 $26,400 $30,800 $35,200
Fixed overhead:
Supervision $1,000 $1,000 $1,000
Depreciation $2,000 $2,000 $2,000
Rent $2,500 $2,500 $2,500
Total fixed costs $5,500 $5,500 $5,500
Total production costs $31,900 $36,300 $40,700
Total profit $28,100 $33,700 $39,300
 14.1.2 Flexible budget
Actual vs Flexible Performance Reports: Quarterly Production Costs
Actual Flexible Budget Variances
Units sold 3,500 3,500
Sales revenue $63,000 $70,000 $7000 A
Production costs:
Variable:
Direct materials $11,000 $10,500 $500 A
Direct labour $8,750 $8,750 0
Variable overhead
Indirect labour $7,100 $7,000 $100 A
Power $1,480 $1,750 ($270) F
Supplies $2,640 $2,800 ($160) F
Total variable cost $30,970 $30,800 $170 A
Fixed overhead:
Supervision $830 $1,000 ($170) F
Depreciation $2,000 $2,000 0
Rent $2,670 $2,500 $170 A
Total fixed costs $5,500 $5,500 $0
Total production costs $36,470 $36,300 $170 A
Total profit $26,530 $33,700 $7170 A
 14.2.1 Performance report using flexible budget
Managerial Performance Report: Quarterly Production
Flexible
Actual Flexed Fixed
Budget Volume Variance
Results Budget Budget
variances (5) = (2) – (4)
(1) (2) (4)
(3) = (1) – (2)
Units sold 3,500 3,500 3,000 500 F
Sales revenue $63,000 $70,000 $7,000 A $60,000 $10,000 F
Production costs
Direct material $11,000 $10,500 $500 A $9,000 $1,500 A
Direct labour $8,750 $8,750 0 $7,500 $1,250 A
Indirect labour $7,100 $7,000 $100 A $6,000 $1,000 A
Power $1,480 $1,750 $(270) F $1,500 $250 A
Supplies $2,640 $2,800 $(160) F $2,400 $400 A
Supervision $830 $1,000 $(170) F $1,000 0
Depreciation $2,000 $2,000 0 $2,000 0
Rent $2,670 $2,500 $170 A $2,500 0
Total costs $36,470 $36,300 $170 A $31,900 $4400 A
Total profit $26,530 $33,700 $7,170 A $28,100 $5,600 F
 14.2.1 Performance report using flexible budget

Management by exception

“Selective investigation of significant variances allows managers to focus only on areas that
need attention. This process is called management by exception.” (Hansen, 2007, p.276)
 14.2.2 Responsibility accounting

“A responsibility centre is a segment of the business whose manager is accountable for specified
sets of activities.” （Hansen, 2007, p.337）

“Responsibility accounting is a system that measures the results of each responsibility centre
and compares those results with some measure of expected or budgeted outcome.” (Hansen, 2007,
p.337)

We have learnt four types of responsibility centre in chapter 3. Now, it is a good opportunity to
have a quick revision.

4 types:
Cost centre: manager accountable for costs only.
Revenue centre: manager accountable for revenues only.
Profit centre: manager accountable for revenues and costs.
Investment centre: manager accountable for investments, revenues and costs.
 14.2.3 Principle of controllability

Responsibility also entails accountability. Accountability implies performance measurement,

and therefore, it is necessary to distinguish controllable and uncontrollable factors for
managers of responsibility centres.

“Controllability is the degree of influence that a specific manager has over costs, revenues
or other items in question.” (Bhimani, 2015, p.488)

“A controllable cost is a cost which is capable of being regulated by a manager within a

defined boundary of responsibility.” (Weetman, 2010, p.488)

“A non-controllable cost is one which is not capable of being regulated by a manager

within a defined boundary of responsibility, although it may be a cost incurred so that the
responsibility may be exercised.” (Weetman, 2010, p.413)
 14.3 Behavioural aspects of budgeting

14.3.1 Goal congruence vs Dysfunctional behavior

Goal congruence is a situation in which people in multiple levels of an organization share

the same goal. A well-thought-out organizational design causes goal congruence and results
in an organization being able to work together to accomplish a strategy. (Bragg, 2008)

Dysfunctional behaviour involves individual behaviour that is in basic conflict with the
goals of the organization. (Hansen, 2007, p.800)
Chapter 15
Capital budgeting and project appraisal
 15.1 Capital investment decisions

15.1.1 Capital expenditure vs Revenue expenditure

• Capital expenditure 投资性支出

Capital expenditure spending on resources which bring a long-term benefit to an organisation,
in generating cash flows or providing other benefits relating to the purpose of the organisation.
(Weetman, 2009, p.G12) (refurbishment)

• Revenue expenditure 收入性支出

Revenue expenditures are for costs that are related to specific revenue transactions or
operating periods, such as the cost of goods sold or repairs and maintenance expense.
(‘Capital Expenditure Versus Revenue Expenditure’)

To conclude, capital expenditures appear as an asset on a company’s balance sheet. Revenue

expenses are listed with the statement of profit or loss.
 15.2 Discounted cash flows

15.2.1 Cash flow vs profit

“Cash flow is the inflow and outflow of money from a business. It is necessary for
daily operations, taxes, purchasing inventory, and paying employees and operating
costs.” (Beers, 2019)

“Profit is the surplus after all expenses are deducted from revenue. Profit is the
overall picture of a business, and the basis on which tax is calculated.” (Beers, 2019)
 15.2.2 Relevant cash flows

Relevant costs are the costs appropriate to a specific management decision. They are those
future costs which will be affected by a decision to be taken. (Weetman, 2010, p.512)

Three characteristics of relevant cost are Future, Incremental, and Cash flow.
• Future：Related costs refer to costs incurred in the future rather than in the past.
• Cash flow: Related costs are cash flows (for example, depreciation is the book processing
of accounting, not cash flows, it is irrelated costs).
• Incremental：The occurrence of relevant costs is related to decision-making.

• Opportunity costs – the value of a benefit sacrificed when one course of action is chosen
in preference to an alternative.
• Avoidable costs – the specific costs of an activity or sector of a business which would be
avoided if that activity or sector did not exist.
 15.2.2 Relevant cash flows

Non-relevant will not be affected by the decision.

• Sunk costs: costs that have already been incurred. It’s historical costs, not future
costs.
• Notional costs: non-cash items such as depreciation or the apportionment of
general overheads (OAR).
• Committed costs: usually a long term-contract already committed by previous
decision, not the specific decision under consideration
 15.2 Discounted cash flows

15.2.3 Time values of money

Interest is defined as borrowing cost because interest is charged on the loan balance. Interest can be
calculated in two ways: simple interest and compound interest.

15.2.3.1 Simple vs compound interest

Simple interest is calculated on the principal, or original, amount of a loan. ( Picardo, 2019)

Simple Interest Formula: Simple interest = P×i×n

Where:
P = Principle
i = interest rate
n = term of the loan
 15.2.3.1 Simple vs compound interest

“Compound interest is calculated on the principal amount and also on the accumulated interest
of previous periods, and can thus be regarded as ‘interest on interest’.” ( Picardo, 2019)

Compound Interest Formula:

Compound interest =[𝐏(𝟏+𝐢)𝐧]−𝐏=𝐏[(𝟏+𝐢)𝐧−𝟏]

Where:
P = Principle
i = interest rate in percentage terms
n = number of compounding periods for a year
 15.2.3.2 Nominal vs effective interest

“The nominal interest rate is the stated interest rate of a bond or loan, which signifies the
actual monetary price borrowers pay lenders to use their money.” (Cussen, 2019)

Nominal interest rate is also defined as fixed interest rate. This interest is calculated as
simple interest during the payment period. If the loan's nominal interest rate is 6%, the
borrower needs to pay interest of $30 every six months and $60 every year for every $1000
borrowed.

“Investors and borrowers should also be aware of the effective interest rate, which takes the
concept of compounding into account.” (Cussen, 2019)

The effective interest rate is the interest rate that meets the compound interest period during
the payment period. It is applicable to compare the annual interest rate of loans in different
compound interest periods (such as weekly, monthly or annual interest payment). Generally,
the nominal interest rate is lower than the effective interest rate.
 15.2.3.2 Nominal vs effective interest

For example, suppose the interest rate of a bond is 4% per year and the compound interest is paid
semi annually. In that case, the investor who invests $2000 in the bond will receive $40 (2,000×
0.02) interest after the first six months and $40.80 (2,040 × 0.02) interest after the next six
months. The investor received a total of $80.80 throughout the year. In this case, when the
nominal interest rate is 4%, the real interest rate is 4.04%.
𝒓 𝒎
𝒊𝒆 = (𝟏 + ) −𝟏
𝒎
Where:
𝒊𝒆 = the effective rate
r = the nominal rate
m = number of compounding periods for a year
 15.2.3.3 Compounding and discounting

“Compounding method is used to know the future value of present money. Conversely,
discounting is a way to compute the present value of future money.” (S & says, 2018)

Compound interest refers to the interest arising from the principal plus accrued interest. At
the end of the first period, the interest is calculated only according to the principal. At the
end of the second period, the interest shall be calculated according to the principal's sum plus
the first period's interest. That is, if the interest rate remains unchanged, the future value can
be calculated by the following formula:

𝒏
𝑭𝑽 =𝑷 𝟏 + 𝒓
Where:
FV = Future value
P = Principle
r = interest rate per period
n = number of periods
 15.2.3.3 Compounding and discounting

In contrast to compound interest, discounting involves calculating the present value of

future cash flows. The value of $1 in the future is lower than that of $1 today. This concept
is called the time value of money. This is a very important concept in project evaluation
because usually, the project's cash flow will last until the future. In this case, the future cash
flows can not be simply added together but must first be discounted to present value.
To discount the future cash flow to the present value, we first need to deform the future
value formula to obtain the present value (PV):

𝟏
𝑷𝑽 =𝑭𝑽×
𝟏+𝒓 𝒏
 15.2.3.3 Compounding and discounting

Present value table

In ACCA MA exam, we can calculate the present value of a given future value by using discount
factor stated in Present Value Table.
 15.2.3.3 Compounding and discounting

Annuity table
“An annuity table is a tool for determining the present value of a structured series of payments.”
(Kagan, 2019)

The annuity table provides a factor based on time and discount rate, through which the annuity
payment can be multiplied to determine its present value. For example, if the expected interest
rate is 12%, you can use the annuity to calculate the present value of an annuity that pays $800 a
year and lasts for 8 years.
15.2.3.3 Compounding and discounting
 15.2.3.3 Compounding and discounting

Perpetuity
“Perpetuity refers to an infinite amount of time. In finance, perpetuity is a constant stream of
identical cash flows with no end.” (Kagan, 2019)

The present value of perpetuity is given by the formula:

𝒂
𝑷𝑽 =
𝒓
Where:
a is the payment per period.
r is the cost of capital as a proportion.
$1
The PV of $1 per annum in perpetuity at a discount rate of 15% would be: = $6.67
0.15
 15.3 Appraisal methods

15.3.1 Net present value

“The net present value (NPV) of a project is equal to the present value of the cash inflows
minus the present value of the cash outflows, all discounted at the cost of capital.” (Weetman,
2010, p.511)

“The rate of interest used in the calculation of net present value is called the discount rate. It
is based on the cost to the business of raising new finance. This is called the cost of capital.”
(Weetman, 2010, p.509)
 15.3.1 Net present value

According to Bhimani, using the NPV method entails the following steps:

Step 1: Sketch the relevant cash inflows and outflows.

Step 2: Choose the correct compound interest table.

Step 3: Sum the present-value figures to determine the net present value.
 15.3.1 Net present value

The NPV decision rule is as follows:

Where the net present value of the project is positive, accept the project.
Where the net present value of the project is negative, reject the project.
Where the net present value of the project is zero, the project is acceptable in meeting.

（Weetman, 2010, p.273）

When judging the feasibility of the project by the NPV method, the company's
management must also weigh non-financial factors. For example, consider whether the
new investment will increase the company's reputation, whether it will be beneficial to
environmental protection, whether it will attract more consumers and increase
customer satisfaction. Therefore, if the NPV is negative, the management will need to
judge whether the benefits exceed the losses caused by the negative NPV.
 15.3.2 Internal rate of return

“The internal rate of return (IRR) is the discount rate at which the present value of the
cash flows generated by the project is equal to the present value of the capital invested, so
that the net present value of the project is zero.” (Weetman, 2010, p.277)

“The primary decision rule with IRR is to accept only projects with an IRR greater than the
discount rate. If there are mutually exclusive projects each with IRR greater than the
discount rate, the rule is to select the project with the highest IRR.” (Coombs, 2005, p.267)

When judging the project's feasibility by IRR (internal rate of return), the main principle is
that if the internal rate of return exceeds the discount rate, the project will produce positive
returns. From another perspective, IRR can be regarded as the highest capital cost that the
project can bear and still bring benefits to shareholders.
 15.3.2 Internal rate of return

The relationship between the NPV and IRR methods:

-10 0 10 20 30 40 50 60 70

NPV
($’000)
IRR

0 10 20 30 40
Rate of return
(%)
 15.3.2 Internal rate of return
If the discount rate is zero, NPV will be the sum of cash flows in each period. In other words,
the time value of money will not be considered. However, we assume that if the discount rate
continues to increase, the project's net present value will decrease accordingly. In the above
figure, when the curve of NPV crosses the horizontal axis, NPV is zero, and its
corresponding point is IRR.

We need to find different discount rates and calculate two NPVs to calculate IRR. And one
NPV should be negative and the other NPV should be positive. Once we have two NPVs,
we can use the following formula to calculate IRR:

𝑁𝑃𝑉1
𝐼𝑅𝑅=𝑅1+(𝑅2−𝑅1)×
𝑁𝑃𝑉1−𝑁𝑃𝑉2
Here R1 is the first discount rate, producing a positive NPV1. R2 is the second discount rate,
producing a negative NPV2.
 15.3.3 Payback period vs Discounted payback period

“The payback method measures the time it will take to recoup, in the form of net
cash inflows, the net initial investment in a project.” (Bhimani, 2015, p.429)

“A discounted payback period gives the number of years it takes to break even
from undertaking the initial expenditure, by discounting future cash flows and
recognizing the time value of money.” (Kenton, 2019)
Part E Standard costing
Chapter 16
Standard costing
 16.1 Standard costing systems

16.1.1 Concepts and purpose of standard costing

Definition of standard costing

Standard costing is a system of accounting based on pre-determined costs and revenue per
unit which are used as a benchmark to assess actual performance and therefore provide
useful feedback information to management.

Coombs (2005, p.156) argued that “a standard cost is the planned unit cost of a product or
service. It normally has a physical and a financial component.”

• The standard cost card of a chocolate cake is set out below:

 16.1.1 Concepts and purpose of standard costing
STANDARD COST CARD - CHOCOLATE CAKE

Description Standard Price Standard Usage Standard Cost Subtotal

Direct materials:
Egg $0.02 100g = $2
Milk $0.02 160g = $3.20
Flour $0.01 200g = $2
Chocolate $0.20 100g = $20
Sugar $0.01 80g = $0.80
Butter $0.03 130g = $3.90
Container $1.00 1g = $1.00
Total direct materials $32.90
Direct labour:
Machine operators $5 0.50hr. = $2.50
Total direct labour $2.50
Prime cost $35.40
Variable overhead $3 0.50hr. = $1.50
Variable production cost $36.90
Fixed overhead $10 0.50hr. = $5.00
Total standard unit cost $41.90
 16.1.1 Concepts and purpose of standard costing

The purpose could cover any or all of the following:

• To provide product costs for stock valuation;

• To increase control within a budgeting system;
• To evaluate performance of a business unit by use of variance analysis;
• To integrate costs in the planning and pricing structure of a business;
• To reduce record-keeping costs when transactions take place at different prices.
 16.1.1 Concepts and purpose of standard costing

Types of standards

• Ideal standard
An ideal standard is a standard which can be attained under perfect operating
conditions: no wastage, no inefficiencies, no idle time, no breakdowns.
E.g. 100% efficiency from labour and from machines.
Could form the basis for long-term aims, but not useful for variance analysis
because unattainable.

• Basic standard
A basic standard is a long-term standard which remains unchanged over the
years and is used to show trends. It is only really of use in very stable situations
where there are unlikely to be fluctuations in prices, rates etc.
 16.1.1 Concepts and purpose of standard costing

• Current standard
This is the current attainable standard which reflects conditions actually applying
in the period under review. Current standards do not attempt to improve on current
levels of efficiency. This should be used for performance appraisal, but the
calculation of a ‘fair’ current standard can be complicated and time-consuming.

• Attainable standard (expected standard)

An attainable standard is a standard which can be attained if production is carried
out efficiently, machines are properly operated and/or materials are properly used.
Some allowance is made for wastage and inefficiencies. This is a standard
expected to apply to a specific budget period and is based on normal efficient
operating conditions. This is used for variance analysis routine reporting.
16.2.1 Direct material variance
 16.2.1 Direct material variance

➢ Direct materials price variance

MPV = (AP – SP) × AQ

计算价差，先将实际价格AP与标准价格SP做差，用实际原材料采购量AQ来量化

= (AP × AQ) – (SP × AQ)

即，衡量的是实际购买原材料花的钱 vs. 买这么多原材料本该花多少钱
 16.2.1 Direct material variance

➢ Direct materials usage variance

MUV = (AQ – SQ) × SP

计算量差，先将实际用量AQ和标准用量SQ做差，用标准价格SP($ per kg)来货币化

= (SP × AQ) – (SP × SQ)

即，衡量的是实际原材料使用量（的标准开销）vs. 生产这么多产品本该使用多少原材
料（的标准开销）

* SQ = actual units * standard kg per unit

 16.2.1 Direct material variance

What if quantity purchased ≠ quantity used？

 16.2.2 Direct labour variance

➢ Direct labor rate variance

LRV = (AR – SR) × AH

计算价差，先将实际价格AR与标准价格SR做差，用实际人工小时AH来量化

= (AR × AH) – (SR × AH)

即，衡量的是实际支付的工资 vs. 这么多小时本该支付的工资
 16.2.2 Direct labour variance

➢ Direct labor efficiency variance

LEV = (AH – SH) × SR

计算量差，先将实际工作小时AH和标准工作小时SH做差，用标准价格SR($ per hour)来
货币化

= (AH × SR) – (SH × SR)，

即，衡量的是实际人工小时（的标准开销）vs. 生产这么多产品本该使用多少人工小时
（的标准开销）

* SH = actual units * standard hour per unit

 16.2.2 Direct labour variance

So… how to deal with idle time?

 Variable overhead
expenditure
variance
Variable overhead
variance
Variable overhead
efficiency variance
Overhead
variance
Fixed overhead
expenditure
variance
Fixed overhead Fixed overhead
variance efficiency variance
Fixed overhead
volume variance
Fixed overhead
capacity variance
 16.2.3.1 Variable overhead variance

➢ Variable overhead expenditure variance

= (AP – SP) × AH
计算价差，先将实际价格AP与标准价格SP做差，用实际人工小时AH来量化

= (AR × AH) – (SR × AH)

即，实际发生的变动生产费用 vs. 伴随这么多人工小时本该发生的变动生产费用
 16.2.3.1 Variable overhead variance

➢ Variable overhead efficiency variance

= (AH – SH) × SP
计算量差，先将实际工作小时AH和标准工作小时SH做差，用标准价格来货币化

= (AH × SP) – (SH × SP)

即，衡量的是实际人工小时（的标准变动生产费用）vs. 生产这么多产品本该使用
多少人工小时（的标准变动生产费用）

*SH = Actual units produced * Standard hour per unit

 16.2.3.1 Variable overhead variance

So… how to deal with idle time?

 16.2.3.2 Fixed overhead variance

➢ Total fixed overhead variance

= Applied/absorbed fixed overhead – Actual overhead

= over/under-absorbed
固定生产费用总差异比较的是吸收的固定生产费用和实际发生的固定生产费用之间
的差异，即多吸/少吸
 16.2.3.2 Fixed overhead variance

➢ Fixed overhead expenditure variance

= AFOH – BFOH
比较的是初始纯预算和纯实际固定生产预算开销的差异
 16.2.3.2 Fixed overhead variance

➢ Fixed Overhead Volume Variance （对象为产量）

= Budgeted fixed overhead – Applied/absorbed fixed overhead

= (Standard fixed overhead rate × SQ) – (Standard fixed overhead rate × AQ)
= Standard fixed overhead rate × (SQ – AQ)
= (SQ-AQ) * OAR/unit
16.2.3.2 Graphical Representation of Fixed Overhead Variances

Graph of Fixed Overhead Variances

$

Absorbed

AFO

BFO

Units
 16.2.3.2 Fixed overhead variance

➢ Fixed Overhead Volume Variance的二级差异（对象为人工小时）

1）Fixed overhead efficiency variance

= (AH-SH) × OAR/hour
*AH大为adverse，生产用时比预计多，生产效率低。

2）Fixed overhead capacity variance

= (初始纯Budgeted hour – AH) × OAR/hour
*AH大为favorable，实际工作时长超出原始预算，对企业是好事。
 16.2.3.2 Fixed production overhead variance under marginal costing

There is no fixed overhead volume variance.

Therefore,
Total fixed overhead variance = fixed overhead expenditure variance
 16.2.4 Sales variance

➢ Selling price variance

= (AP-SP) * AQ
销售价格作差，实际销售量量化

➢ Sales margin volume variance

= (AQ-SQ) * standard margin
销售量作差，标准margin货币化
• AC: (AQ-SQ) * standard profit per unit
• MC: (AQ-SQ) * standard contribution per unit
 16.2.5 Interrelationships between the variances

For example, the labour rate variance may be favourable because lower-paid workers
are being used. This could lead to:

• Adverse material usage variance because of a higher incidence of waste;

• Adverse labour efficiency variance because it takes longer hours to make the
equivalent number of products;
• Adverse overhead efficiency variance because the substandard work causes more
hours for a specified output;
• Adverse overhead volume variance arising from abnormally high machine
breakdowns because of less-skilled operators.
16.3.1 Reconcile budgeted profit with actual profit under standard absorption costing

Starting point:
budgeted profit

Sales volume profit variance

Standard profit from

actual sales
Sales price variance
Direct Material variances
Direct labor variances
Variable overhead variances
Fixed overhead variances
Actual profit
16.3.2 Reconcile budgeted profit with actual profit under standard marginal costing

Starting point:
budgeted contribution

Sales volume contribution variance

Standard contribution
from actual sales
Sales price variance
Direct Material variances
Direct labor variances
Variable overhead variances
Actual contribution

Fixed overhead variances (expenditure variance only)

Actual profit
Part F Performance measurement
Chapter 17
Financial measurement
17.1.1 Mission statements, objectives, critical success factors, and performance indicators

Mission statements
“Mission statement normally provides a concise statement of the overall aims, or
intentions, of the business.” (Atrill, 2009, p.7)
Objectives
Critical success factors
Key performance indicators
 17.2 Measures of financial performance

Return on capital employed (ROCE)

Or Return on investment (ROI)
Profitability
Residual income (RI)
Return on sales (ROS), Gross margin

Liquidity Current ratio, Acid test

Measures of
financial performance
Asset turnover, Receivables days,
Activity
Inventory days, Payable days

Gearing Capital gearing, Interest cover

 17.3 Non-financial measures

Weaknesses of FPIs:
1) Managers can potentially manipulate financial measures in isolation, e.g. using different
accounting policies and window dressing.
2) Financial measures are often described as “lagging indicators”, as they become
measurable only after an accounting period has completed.
3) FPIs ignore the drivers of business success, such as quality, innovation and after-sales
services.
4) FPIs may lead to short-termism, e.g. the excessive focus on cost reduction in short term
may be achieved at the expensed of longer-term performance.
 17.3.3 Importance of non-financial performance measures

1) Using a range of financial and non-financial measures makes it more difficult for
managers to hide unsatisfactory performance.
2) They are often referred to as “leading indicators” because they give early warning
signals of problems, and give the firm an opportunity of correcting problems before
they go too far. For example, a firm might be able to address a quality issue revealed
by high level of customer complaints before it damages sales and profit.
3) They encourage managers to take account of the factors that drive success in the long
run.
4) Non-financial measures may be more understandable and relevant to non-financial
staff.
Chapter 18
Application of performance measurement
 18.1.1 Overview

• “Financial — How is success measured by our shareholders?” (Atkinson, 2011, p.19)

• “Customer — How do we create value for our customers?” (Atkinson, 2011, p.19)

• “Internal business process — At which processes must we excel to meet our

customer and shareholder expectations?” (Atkinson, 2011, p.20)

• “Innovation and learning — What employee capabilities, information systems and

organisational capabilities do we need to continually improve our processes and
customer relationships?” (Atkinson, 2011, p.20)
 18.1.1 Overview

A simple version of a balanced scorecard

Perspectives Objectives Measures Targets
Increase shareholder value Share price 50% increase
Increase profits Profits 100%
Financial
Increase revenue Revenue 30% increase
Decrease process cost Costs 20% decrease
Increase market share Market share 25%
Customer Increase customer retention Repeat orders 70%
Improve delivery On-time percentage 100%

Internal business Improve cycle time Cycle time 2 days

process Reduce process Yes or no Yes

Innovation and 30 hours per

Improve employee skill Hours of training
learning employee
 18.1.2 Advantages and limitations of balanced scorecard

According to Atrill (2009, p.337), balanced scorecard has the following advantages
when used as a management and measurement method:
• It aims to strike a balance between external measures relating to customers and
shareholders, and internal measures relating to business process, innovation and
learning.
• It aims to strike a balance between the measures that reflect outcomes (lag
indicators) and measures that help predict future performance (lead indicators).
• It aims to strike a balance between hard financial measures and soft non-financial
measures.
• It is possible to adapt the balanced scorecard to fit the needs of the particular
business.
 18.1.2 Advantages and limitations of balanced scorecard

However, balanced scorecard has its limitations as follow:

• There are often too many measures employed, thereby making the scorecard too
complex and unwieldy.

• Managers are confronted with trade-off decisions between the four different
dimensions, and struggle because they lack a clear compass. (Imagine a manager
who has a limited budget and therefore has to decide whether to invest in staff
training or product innovation. If both add value to the business, which choice will
be optimal for the business?)
 18.2 Economy, efficiency and effectiveness

For non-profit organizations such as the government, its function is to provide the
public with good infrastructure and public services and promote community
development. As the primary user of national resources, the government needs to
continue to find the best way to allocate resources and improve the relationship
between cost input and output results. However, unlike the business operation model,
it is difficult for us to quantify the output of non-profit organizations through
concepts such as price and profit.

Therefore, these three dimensions are critical when evaluating such organizations,
Economy, Efficiency, and Effectiveness.
 18.2 Economy, efficiency and effectiveness

• Economy
“Economy requires feedback on the cost of the inputs to a system.”(“Economy,
efficiency, and effectiveness - Oxford Reference”, 2017)

• Efficiency
“Efficiency measures how successfully the inputs have been transformed into
outputs.” (“Economy, efficiency, and effectiveness - Oxford Reference”, 2017)

• Effectiveness
“Effectiveness measures how successfully the system achieves its desired outputs.”
(“Economy, efficiency, and effectiveness - Oxford Reference”, 2017)
 18.3.3 Benchmarking

“Benchmarking is the continuous process of measuring products, services and activities against
the best levels of performance. Benchmarking enables companies to use the best levels of
performance within their organisation or by competitors or other external companies to gauge
the performance of their own managers.” (Bhimani, 2015, p.531)

Hansen (2007, p.438) categorised benchmarking into several types:

• “Benchmarking against internal operations is called internal benchmarking.”

• “Benchmarking that involves comparison with others outside the organization is called
external benchmarking. The three types of external benchmarking are competitive
benchmarking, functional benchmarking, and strategic benchmarking.”
 18.3.3 Benchmarking

Type Description
Compare one operating unit or function with another within
Internal benchmarking
the same organization.

Internal functions are compared with those of the best external

Functional benchmarking practitioners of those functions, regardless of the industry they
are in (also known as operational or generic benchmarking).

Information is gathered about direct competitors, through

Competitive benchmarking
techniques such as reverse engineering.

A type of competitive benchmarking aimed at strategic action

Strategic benchmarking
and organisational change.