STUDY GUIDE

A Management information systems and data analytics

1 Management information systems

2 Uses and control of information

3 Big data and data analytics

B Specialist cost and management accounting techniques

1 Activity-based costing (ABC)
2 Target costing
3 Life-cycle costing
4 Throughput accounting
5 Accounting for environmental and
sustainability factors
C Decision-making techniques
1 Relevant cost analysis
2 Cost volume profit analysis (CVP)
3 Limiting factors
4 Pricing decisions
5 Make-or-buy and other short-term decisions
6 Dealing with risk and uncertainty in decision-
making

D Budgeting and control

1 Budgetary systems and types of budget
2 Analytical techniques in budgeting and
forecasting
3 Standard costing
4 Material mix and yield variances
5 Sales mix and quantity variances
6 Planning and operational variances
7 Performance analysis
E Performance measurement and control
1 Performance analysis in private sector, public sector and not-for-profit
organizations

2 Divisional performance and transfer pricing

3 Specific performance analysis issues in not-for-profit organizations and the public

sector

F Employability and technology skills

1 Use of computer technology to efficiently access and manipulate relevant information
2 Work on relevant response options, using available functions and technology, as would
be required in the workplace
3 Navigate windows and computer screens to create and amend responses to exam
requirements, using the appropriate tools
4 Present data and information effectively, using the appropriate tools

Section A 15 objective test questions 30 marks

Section B 3 case style questions: 5 OTQs each 30 marks
Section C 2 constructed response questions 40 marks
- Performance measurement and control
- Decision-making techniques and/or budgeting and control
Total 100 marks
CHAPTER 1: MANAGEMENT INFORMATION SYSTEMS AND
DATA ANALYTICS
 Objective: information needs + technologies & systems to manage and measure performance
1.1 Managing information
1.1.1 Information systems
- Information systems consists of computer hardware and software, and communication
networks to collect, store, process and communicate information
- Provide the information required to assist management
+ Planning: long-term strategic direction & medium and short term
+ Controlling: perform against the plan & take actions for any significant deviations
+ Decision-making: provide information at many levels

Products/markets to be in
Investment decisions
Strategic Planning for environmental changes
planning Identifying competitive advantage
(BOD)
Obtained and used resources effectively and
efficiently
Tactical management Implementing strategic decisions
(middle level of Preparing annual budgets
Recruiting staff
management)

Routine planning (staff rotas: rosters,

schedules)
Operational management Programmed decisions based on
internal, transaction-based information
(day-to-day running) (ordering inventory)

- Costs:
+ Pre-implementation/development costs + Initial set-up costs (licensing, installing)
+ Data conversion of historical information + Staff and user training & IT support
+ Modifications & system upgrades + Communication charges (internet access)
1.1.2 Information technology
- Internet
- Intranet: subset of internet, only authorised users can access
 - Wireless technology
- Network technology
1.1.3 Principal controls
- Purpose: reports prepared only when benefits > costs, only sent to relevant managers
- Types: format agreed in advance & distribution lists
1.1.4 Confidential information
Information security - protects the interests of those relying on information from harm
resulting from hacking, operational error, sabotage and other threats
Security – protection of the system from harm
Privacy – restriction of knowledge to authorized persons
- General security controls
+ Training all staff to create: an appropriate attitude of mind & strong security culture
+ Staffing arrangements should include:
 Authorization for access and change routines to programs
 Segregation of duties
 Thorough vetting of job applicants before being employed
 Appropriate procedures for cleansing of security access for terminated staff
 Risk analysis on sensitive staff
- Physical access controls: security guards and cameras; time controls; electronic door
locks (PIN, card or bio-data entry)
- Logical access controls: system passwords; usage logs
- Hacking: authorization attack & trapdoor/backdoor attacks
1.2 Sources of information
- Internal: accounting system, inventory, payroll, purchase processing, sales processing,
qualitative information (e.g, customer satisfaction)
- External: primary (tailored information) & secondary (data for general use)
1.3 Information systems and data analytics
1.3.1 Accounting information requirements
- Strategic: profits by business segment; external factors influencing the organization;
market studies; investment appraisal
- Tactical: + Contain forecasts over periods up to 12 months
+ More detailed: detailed SOPL analysing revenue & costs by division/product
 + Be mainly internal and provided regularly: monthly analysis of revenues compared
with budgets and variance analysis
- Operational: transaction-based data (e.g, variances; receivables/payable levels; payroll
details; customer complaints; output records)
1.3.2 Information systems
STRATEGIC Executive Information System - Assist senior-management
(EIS) - Allows users to customize their
view to focus on information most
relevant to them
TACTICAL Decision Support System (DSS) A computer-based information
system often utilising analytical
modelling techniques
Management Information System Obtain data => process to produce
(MIS) useful information => distribute to
relevant managers
OPERATIONA Transaction Processing System - High-frequent & short-term data
L (TPS) - Automated processing with
limited human input
- Approaches: (1) Batch
processing (e.g, payroll
transactions) (2) Real-time
systems processing
- Enterprize Resource Planning System (ERP): provides a seamless flow of information
across an entire organisation using a shared database
- Customer Relationship Management System (CRM)
1.3.3 Big data
Big data - vast data sets that may be analysed to reveal patterns, trends and associations,
especially relating to human behaviour and interactions
Structed data - data stored within defined fields within a defined record, along with
similar data, according to the specifications laid down in a data model. The data model
limits the data collected and how it can be processed
Unstructured data - information gathered in various forms and ways, not in accordance
 with any data model, and thus may be difficult to store or analyse
- Data analytics: Data testing – Data mining – Predictive analytics – Text analytics –
Statistical analytics

- Characteristics: 5Vs

Volume a tremendous amount

Variety non-uniform, from internal and external sources, some structured but
primarily unstructured
Velocity fast and continuous

Veracity is the data valid, and can its accuracy be relied upon?

Value costly in terms of facilities needed and staff time spent

- The big data (DIKW) pyramid

Improved decision-making from the understanding

WISDOM

Understanding data relationships

KNOWLEDGE

Identifying data relationships

INFORMATION

Facts and figures

DATA

1.4 Presenting and interpreting data

- Tables
- Charts and graphs
+ Line chart: trends over time (e.g, sales and revenue growth)
+ Bar chart: comparisons (e.g, comparing budget revenue per month against actual
results)
+ Pie chart: relative comparison to a whole (e.g, sales in different regions)
+ Scatter diagram
CHAPTER 2: COST AND MANAGEMENT ACCOUNTING
2.1. Scope of traditional management accounting

2.2. Traditional costing

Marginal costing
- Fixed overheads are NOT INCLUDED in unit costs => PERIOD COST
- Inventory valuation includes ONLY the VARIABLE costs of production
Absorption costing
- Volume of output determines costs
- Fixed production overheads must be
[1] ALLOCATED: cost centers
[2] APPORTIONED: when an overhead is common to multiple cost centers

[3] RE-APPORTIONED: service cost centers => production cost centers

[4] ABSORBED
2.3. Activity-based costing: an approach to the costing and monitoring of activities which
involves tracing resource consumption and costing final outputs. Resources are assigned to
activities and activities to cost objects. The latter use cost drivers to attach activity costs to
outputs.
Cost drivers: a factor which can cause a change in the cost of an activity
Steps

Analysis
 Advantages Disadvantages
(costs per unit are more accurate)
Better decision-making: more accurate ABC is still based on budgeted overheads
knowledge of cost and profit per unit  evaluate in the current period  unsuitable for
whether to stop producing loss-making products future strategic decisions
Where cost-plus pricing is used, applying ABC It is more complex, and the selection of
means that the price will be more likely to cost drivers may not be straightforward:
achieve the desired margins. - There may be more than one possible
Better understanding of what causes costs cost driver for a particular overhead, so
resulting from identifying the cost driver  some judgment is required in selecting an
enables managers to make more informed appropriate driver
decisions on actions to reduce costs - As not all costs will be easily identified
Control of overheads is more straightforward, with particular cost pools, some allocations
as responsibility for incoming costs must be will be arbitrary
established before ABC can be implemented
More accurate performance measurement Additional time and cost will be incurred
leads to better performance management to set up and administer the system
CHAPTER 3: ADVANCES IN MANAGEMENT ACCOUNTING
3.1. Developments in management accounting
Traditional management accounting: inward-looking, focusing on controlling costs
- Costing systems (marginal and absorption costing)
- Budgeting systems
- Standard costing and variance analysis
- Working capital management
Business environment changes
Growth of services industries: SHIP
- Simultaneity (inseparability): the service is consumed simultaneously as it is performed
- Heterogeneity (variability): standard
- Intangibility
- Perishability: cannot be stored
- Non-transferability of ownership
Adding value and avoiding waste
- Total Quality Management (TQM): getting it right the first time
- JIT Manufacturing: pull through philosophy – customer demand drives production
=> JIT purchasing: raw materials are received when needed for production, so raw
material inventory is reduced to near-zero levels (inventory holding costs are low, but
ordering costs are high)
Response of management accountants
3.2. Target costing: emphasizes cost control through good product design and
production planning
Aim and use
- Traditional cost-plus: cost + profit margin = price
- Price determined by the market => companies have to accept
- Target costing attempts to achieve an acceptable margin in a situation where the price of
a product is determined externally by the market. This margin is achieved by identifying
ways to reduce the product's costs.
  Most appropriately used during the design phase of a product (where cost savings can be
identified by changing the design of the product to avoid unnecessary costs from being
designed into the product)
Steps
- Determine the price the market will accept
- Deduct a required profit margin from this price => target cost
- Estimate the actual cost of the product
- Identify ways to narrow the gap between the actual costs and the target costs
Application to service industries
- Target costing is likely most appropriate in manufacturing industries, where a volume of
standard products is to be made
Narrowing the target cost gap: ensure that the perceived value of the final product/service
is not reduced (which would lead to lower effective selling prices)
- Reconsider the design to eliminate non-value-added elements
- Reduce the number of components or standardise components
- Use less expensive materials
- Employ a lower grade of staff on production (if the production process does not require
specialist skills)
- Invest in new technology
- Outsource elements of the production or support activities
- Reduce manning levels or redesign the workflow
 Tear down analysis (reverse engineering): examining a competitor’s product to
identify possible improvements/costs reduction
 Value engineering: investigating factors that affect the cost of a product/service to
improve the design of a product so the same functions can be provided for a lower cost or
save cost by eliminating those the customer does not value => applied to new
product/service at the beginning of the development process during the design stage
(i.e. before production starts)
4 elements of value:
o Utility or use value: how useful the product is to the owner
o Esteem value: how the product increases the owner’s well-being
o Scarcity value: how rarity impacts value
 o Exchange value: the amount the owner sells the product for
 Functional analysis
3.3. Life-cycle costing
Product lifecycle

- Development stage (planning and design stage): negative cash flow, no revenue
- Introduction phase/launch: market skimming, market penetration
- Growth: competition rises => force lower prices
- Maturity: most profits are made, stable prices => focus on maximizing short-term profits
- Decline: prices fall, unless a niche market found
Costs involved
- Commited costs: not incurred during the design phase, the company is committed to
incurring future expenditures (mainly during manufacturing) (common: 80% total costs
over the product’s life)
 - Cost behavior
Stage Fixed costs Variable costs
Planning and Product design
design Buidling prototypes
Market research
Manufacturing Marketing and advertising Materials and components
and sales Fixed production and sales Direct labour
overheads Variable production and non-production
Design updating overheads
Sales commissions
Service and Decommissioning factories Servicing (may be outsourced)
abandonmen Disposal of products
- Strategies to extend product maturity
o Issuing updated versions of the product, which include new features. The costs of
developing updates for an existing product are likely considerably less than the cost
of creating an entirely new product.
o Repackaging the product to give it a new image
o Selling the product in new markets. This could be new geographical markets or
aiming the product at new market segments (e.g. by discounting the price).
3.4. Throughput accounting: producing for sale, not work-in-progress
The theory of constraints: Processs to maximize profit when faced with bottlenecks
1. Identify the system’s bottlenecks
2. Decide how to exploit the bottlenecks identified in (1)
 3. Subordinate everything else to the decisions made in (2): ensure that other resources
do not produce at a higher rate than the bottleneck
4. Elevate the system’s bottlenecks (i.e. elevate production capacity by buying additional
machines (capacity investment), training the machine operators or reducing the time
spent on the bottleneck resource)
5. If a new constraint is broken in (4), return to (1)
Throughput contribution = Sales revenue – Direct material costs
The fixed elements in this technique include overheads and labour, which may collectively
termed “conversion costs”
Throughput accounting ratio (TPAR) = Contribution per hour / Fixed cost per hour

*Other factory cost would NOT include administration or marketing costs

=> In throughput accounting, ALL costs except material costs are treated as fixed in
the short term
- If TPAR > 1, the product is profitable (throughput contribution > fixed costs)
- If TPAR = 1, the product breaks even
- If TPAR < 1, the product is loss-making
 Ways to improve the TPAR: eliminate bottlenecks or reduce the time spent on
bottleneck resources; reduce other factory costs
3.5. Environmental accounting
Environmental Management Accounting (EMA)
- Physical information: focuses on the physical use of scarce resources and how much
waste occurs
- Monetary information on environment-related costs, earnings and savings
Environmental costs
 o Conventional costs: environmental-related costs (e.g. buying energy and other
scarce resources)
o Potentially hidden costs: those environmental costs that are recorded but included
in general overheads, so management is unaware of them
o Contingent costs: potential future costs (e.g. cleaning up damage caused by
pollution)
o Image and relationship costs: incurred producing environmental reports and
promoting the company's environmental activities
- Based on the costs of quality
o Environmental prevention costs are incurred by activities undertaken to prevent
waste production (e.g. spending on redesigning processes to reduce the amount of
pollution released into the atmosphere)
o Environmental detection costs are incurred to ensure that the organisation complies
with regulations and voluntary standards (e.g. costs of auditing the organisation's
environmental activities)
o Environmental internal failure costs are incurred to clean up environmental waste
and pollution before it has been released into the environment (e.g. costs of
disposing of toxic waste)
o Environmental external failure costs are incurred on activities performed after
discharging waste into the environment (e.g. cleaning up an ocean after spilling oil)
EMA techniques
- An environmental cost report based on the costs
- Environmental activity-based costing
- Input-output analysis
 - Flow cost accounting
o material costs
o system costs - incurred within the various processes that add value to the product (e.g.
wages and overheads)
o delivery and disposal costs - incurred in delivering goods to customers or disposing of
waste
- Life-cycle costing
3.6. Sustainability issues
Accounting for environmental and sustainability factors: Environment, Social and
Governance (ESG)
Sustainability strategy perspectives
Role of accountants in developing sustainable practices
- Leadership and business strategy: make sustainability strategic, not just tactical
- Management, operations and accounting: improve the process of information
and data collection, analysis and reporting
- Communications, reporting and disclosure: integrate with reporting
CHAPTER 4: RELEVANT COST ANALYSIS (short-term decisions)
4.1. Relevant costs: are those costs that are affected by a specific management decisions
- Future costs and revenues
- Incremental
- Cash flows (e.g. cash payments or receipts)
 Relevant costs: avoA=
 =-09876Aidable costs, controllable costs
 Variable production materials costs are incremental; if production increases, the costs
of materials and labour, etc., increase. Fixed production costs that do not increase
are not incremental and are therefore irrelevant.
Non-relevant costs
- Sunk costs: research and development costs
- Committed costs: contract rental and lease payments (if a contract is cancellable, such
payments are not committed, and any penalty costs incurred would be relevant)
- Fixed costs: but an increment “step” in a fixed costs will be relevant
- Depreciation/amortization and carrying value
- Uncontrollable costs: management charges (e.g. reallocated non-production overheads)
- Notional costs: recharges of head offices costs or management charges
4.2. Opportunity cost
- Opportunity cost: the value of the benefit sacrificed when one course of action is
chosen, in preference to an alternative. The opportunity cost is represented by the
foregone potential benefit from the best rejected course of action
 Apply to the use of scarce resources
 ALL opportunity costs are RELEVANT
4.3. One-off contracts
Minimum price: makes a contract worthwhile is equal to the relevant cost; at this price no
profit or loss would be made on the contract
Materials
  Non-relevant information: sunk costs (historically incurred), historical
purchase prices, and carrying value!
Labor

- Spare (idle) labor time => relevant cost = 0

- Additional labor time
Without taking workers away => direct cost of the labor, may be higher rate if OT
involved
 Limit labor available, taking workers aways => direct cost + lost contribution
Non-current assets
- Rented (hired): rental costs
- Acquired (purchased): cost of acquiring (related costs: delivery and installation)
- Owned
Not used for other purposes (has spare capacity): fall in realizable value
Already operating at full capacity: deprival value (value in use vs. replacement cost)
 Two-stage decision:
(1) Should the asset be kept in use in the business or sold (EV ? NRV)
(2) If deprived of the asset (e.g. through sale or use elsewhere), will it be replace?
 Deprival value is the LOWEST cost option

Non-financial factors
4.4. Shut-down decisions
- If positive contribution is being generated after all attributable costs, division should not
be shut down.
- Allocated fixed costs from head office should not be included in shut-down decision.
4.5. Further processing decisions
- Joint products have significant relative sales value
- A by-product is produced with one/more main products but has a small relative sales
value
- Once the products have reached the split-off point:
+ It may be possible to sell the product immediately in its current state.
 + The product may require further processing before it can be sold if incremental
revenue > incremental costs
4.6. Make or buy
Outsourcing
Advantages:
- Lower cost
- Service may become variable cost rather than a fixed cost
- Outsourcing allows management to focus on the core competencies of the business
without being distracted by managing peripheral areas.
- A specialist supplier may be able to supply goods or services of higher quality.
- Access to a broader range of expertise as the provider deals with several clients.
Disadvantages
- Loses control over a part of its business processes due to a third party involved
- Trusting a third party with confidential information about goods or services.
- Some costs may not be apparent (i.e. hidden) as anything not explicitly covered by the
contract will incur additional charges.
- Quality may suffer, especially if the contract price per unit is fixed (i.e. the third party
can only increase its profit by reducing costs)
- Operational dependence on the outsourcing company is linked to its financial
stability. Switching to another provider may be costly if the third-party company fails.
- Demotivate the workforce if the decision to outsource is associated with job losses
Make vs. Buy decisions
- Financial decisions based on whether make or buy-in maximizes incremental
contribution
- If a scarce resource is present, maximize contribution per scarce resource.
- Non-financial factors may apply.
CHAPTER 5: COST VOLUME PROFIT ANALYSIS
5.1. CVP Analysis
Objective: Effects of sales volume on financial results
Breakeven point
- A measure of the LOWEST activity level
- TOTAL CONTRIBUTION = TOTAL FIXED COSTS
5.2. Charts
Breakeven chart
Profit-volume chart

5.3. Mathematical approaches

Contribution
- UNIT CONTRIBUTION = SELLING PRICE – VARIABLE COST PER UNIT
- TOTAL CONTRIBUTION = TOTAL REVENUE – TOTAL VARIABLE COST
Breakeven formula
PROFIT = SALES – VARIABLE COST – TOTAL FIXED COST
 = TOTAL CONTRIBUTION – TOTAL FIXED COST
- At BEP, profit = 0
 Total contribution = Fixed cost
Total contribution = Number of units x Unit contribution
NUMBERS OF UNITS TO BE TOTAL FIXED COST
SOLD TO BREAKEVEN = UNIT CONTRIBUTION
- How to achieve target profit?
SALES VOLUME TO ACHIEVE TOTAL FIXED COST + REQUIRED PROFIT
A TARGET PROFIT = UNIT CONTRIBUTION
SALES REVENUE TO ACHIEVE A TARGET PROFIT
= SALES VOLUME TO ACHIEVE A TARGET PROFIT x UNIT SELLING PRICE
Contribution/Sales (C/S) ratio
- C/S Ratio (or contribution margin): is the proportion of the selling price which
contributes to fixed overheads and profits
CONTRIBUTION PER UNIT TOTAL CONTRIBUTION
C/S RATIO = OR
SELLING PER UNIT TOTAL SALES REVENUE
- Breakeven revenue
FIXED COST
BREAKEVEN REVENUE =
C/S RATIO
REVENUE REQUIRED TO FIXED COST + REQUIRED PROFIT
ACHIEVE A TARGET PROFIT = C/S RATIO
Margin of safety: the amount by which anticipated or existing activity exceeds (or falls short of)
breakeven
In units or $s: MARGIN OF SAFETY = BUDGETED SALES – BREAKEVEN SALES
As a percentage: BUDGETED SALES – BREAKEVEN SALES
x 100%
BUDGETED SALES

5.4. Multi-product analysis

Assumption
- CVP analysis can be extended to multi-product situations if a constant pre-determined
sales mix is applied
- If the assumption of a standard mix is relaxed, there will be no unique BEP
Calculation of breakeven point
 - Weighted avẻrage C/S ratio
TOTAL CONTRIBUTION (from all products)
WEIGHTED AVERAGE C/S RATIO =
TOTAL REVENUE (from all products)
- Sales units at Breakeven Revenue
BUDGETED REVENUE FOR PRODUCT X
REVENUE RATIO FOR PRODUCT X =
TOTAL BUDGETED REVENUE
At breakeven: REVENUE FROM PRODUCT X
= TOTAL BREAKEVEN REVENUE x REVENUE RATIO FOR X
Multi-product profit-volume (PV) charts

5.5. Limitations in planning and decision making

Simplifying assumptions
- Fixed costs remain constant regardless of the production decision. In practice, fixed
costs may not be truly fixed and may vary as output changes. For example, fixed costs
might be stepped in behaviour as production volume increases.
- Variable cost per unit is constant (which may not be the case due to discounts and
other economies of scale).
- Selling price remains constant. This may not be true in practice, where an increase in
sales volume can only be achieved by lowering the price.

Multi-product situations
- Product mix
- PV charts
Advantages:
o Multi-product PV charts enable the user to see easily the relationship between revenue
and profit. Breakeven revenue can also be seen.
o Identifying the most and least profitable products should lead to improved
decisionmaking.
Disadvantages:
o The PV chart assumes either a constant sales mix or assumes that products are sold in
order of increasing C/S ratio. The actual sales mix is likely to deviate from these
assumptions, making the conclusions about breakeven revenue incorrect.
o The chart shows only profits plotted against revenue. It does not show variable costs
or output in units.
o The chart assumes that products can be sold in order of profitability, which ignores the
possibility that sales of one product may depend on sales of another.
CHAPTER 6: LIMITING FACTOR DECISIONS
 Limiting factor analysis: phân tích yếu tố giới hạn để tối đa hoá lợi nhuận góp
(Contribution = Sales – Variable costs)
 Throughput accounting: phân tích nguồn lực giới hạn để tối đa hoá throughput
(Throughput = Sales – Material costs)
6.1. Limiting factors
Limiting factors analysis
- It is possible for production capacity < sales demand due to scarcity (i.e. labor, machine
time, factory space, etc)
- This scarce resource is known as the limiting factor
One limiting factor
- With no limiting factor, maximum production is market demand
- Decision would be to prioritize products that maximize contribution
- Approach: limiting factor => contribution per unit => contribution per unit of limiting
factor => rank
Shadow price (dual price): the maximum price premium (incremental contribution)
that should be paid to obtain one more unit of a scarce resource (limiting factor) – NOT THE
TOTAL PRICE PAID

6.2. Make or Buy

Decisions with a limiting factor: To decide which products should be made and which should
be bought, calculate the saving per unit of scarce resource from making the product rather than
from buying it
SAVING PER UNIT OF BUY IN PRICE – VARIABLE COST TO MAKE
SCARCE RESOURCE = NO. OF UNITS OF SCARCE RESOURCE USED PER UNIT
 Shadow price in Make v Buy = Savings per unit of scarce resource
6.3. Multi-limiting factors (where more than one factor is limited)
The graph
- Define unknowns
- Formulate the objective function, either to maximize contribution or to minimize cost
USE CONTRIBUTION, NOT PROFIT
- Express constraints (limiting factors may include resource constraints, production
constrains and/or levels of demand) in terms of inequalities
- Plot all constraints on a graph and identify the feasible region
Problem formulation
Example
A company makes two products, cabinets and chests. Each product passes through two
departments, carpentry and polishing. The time spent in each department is as follows.
Departmental time (hours)
Carpentry Polishing
Cabinets 3 2
Chests 4 6
There are 4,800 hours available for carpentry, and 5,000 hours available for polishing. Annual
production of cabinets must not exceed 1,200 units. Apart from this, all items produced can be
sold. The contribution to profit and fixed overheads is $100 for a cabinet and $150 for a chest.
Required: Calculate the optimal product mix which maximise total contribution to profit
Step 1 – Define unknowns
Let: x = number of cabinets to be produced per annum
y = number of chests to be produced per annum
C = total contribution to profit
Step 2 – Formulate the objective function
The function to be maximized is the total contribution to profit. Since cabinets and chests
contribute $100 and $150 respectively, for each item produced: C = 100x + 150y
Step 3 – Formulate constraints
4,800 carpentry hours are available to provide 3 hours per cabinet and 4 hours per chest:
3x + 4y ≤ 4,800
5,000 polishing hours are available to provide 2 hours per cabinet and 6 hours per chest:
2x + 6y ≤ 5,000
Production of cabinets must not exceed 1,200 units: x ≤ 1,200
Because production cannot be negative: x ≥ 0, y ≥ 0
Step 4 – Present graphically

Feasible region: With the given constraints, all possible values for x and y lie in the boxed
area of the graph 0ABCD, called the relevant or feasible region. The point on the boundary of
this area must now be found where the contribution (C) has a maximum value.
Step 5 – The objective function
Only one contribution line needs to be plotted to identify the optimal solution.
For example, 100x + 150y = 150,000
The highest possible value of C lies where an iso-contribution line is furthest from the origin
on the edge of the feasible region.

It can be seen that B is the optimal solution.

Step 6 – Solve
B is at the intersection of the two lines: 3x + 4y = 4,800 and 2x + 6y = 5,000
Therefore: x = 880; y = 540
Step 7 – Optimal solution
The optimal solution is to produce 880 cabinets and 540 chests.
 This will give a contribution of C = 100x + 150y = ($100 × 880) + ($150 × 540) = $169,000
Objective function method
Iso-contribution lines: every point on each line gives the same contribution value

- Contribution lines with a higher contribution value are further from the origin (the
point x = 0, y = 0) than those with a lower value
- All iso–contribution lines are parallel to each other
Contribution and the feasible region
- The line representing the lowest contribution value is closest to the origin. The line
furthest from the origin is outside of the feasible region. This means that this level of
contribution could not be achieved.
- Most of the middle contribution line lies outside the feasible region, but point B is on the
boundary of the feasible region, representing the combination of production that is
feasible at which contribution is maximised. It is the last point within the boundary that is
passed by the contribution line before it leaves the boundary.
Slope of the contribution line
- Point B represents the maximum contribution point
- However, had the contribution line been “flatter”, point A could be the point of maximum
contribution

Simultaneous equations method

Example
A manufacturer produces two types of garden furniture − tables and benches. Both use the
same material and are produced by the same workforce, which consists of skilled and
unskilled workers. The managing director is trying to decide on the optimal production plan to
maximise contribution each week.
The following standard cost cards apply:
Table Bench
$ $
 Material ($5/kg) 15 10
Skilled labor ($10/hour) 50 20
Unskilled labor ($4/hour) 16 4
Variable overhead ($2/hour) 18 6
Total variable cost 99 40
Selling price 134 50
Contribution per unit 35 10
There is a shortage of the required material; only 120 kg are available weekly. There are four
skilled workers, each working a 35-hour week. 100 hours of part-time unskilled labour are
available per week.
Required: Formulate this scarce resource problem as a linear programming model.
Let x be the number of tables made per week. Let y be the number of benches made per week.
The objective function to maximize contribution (C), given by 35x + 10y
Subject to constraints:
- Materials 3x + 2y ≤ 120
- Skilled labor 5x + 2y ≤ 140
- Unskilled labor 4x + y ≤ 100
- Non-negative x ≥ 0, y ≥ 0
The linear programming model has been correctly depicted by the following graph:

Required: Determine how many units of each type of furniture should be produced each
week to maximise contribution. Calculate the maximum weekly contribution
The feasible region on the graph is 0ABCD. The dashed line represents the objective function.
Considering the point on the x axis (i.e. y = 0), x = 20 i.e. C = 35x + 10y = 700 (Alternatively,
consider the point on the y axis (i.e. x = 0), y = 70, i.e. C = 35x + 10y = 700
The optimum point is at C, the intersection of the skilled and unskilled constraints.
Solving simultaneously: 5x + 2y = 140 (1)
4x + y = 100 (2)
2 x (2) 8x + 2y = 200 (3)
(3) – (1) 3x = 60
x = 20
By substitution in (2): 80 + y = 100
y = 20
So to maximize contribution, the company should make and sell 20 of each type of unit
Contribution = (20 x $35) + (20 x $10) = $900
Assumptions
- Linearity - contribution and resource utilisation per unit are the same for any quantity
produced and sold in the range under consideration
- Infinite divisibility - of products and resources.The solution may not have integer values
(e.g. 12 1/4 units of x and 9 3/4 units of y) and should not be rounded. For example, for
an optimisation problem:
o rounding up will be to a point outside the feasible region
o if rounding down, it will depend on the gradient of the objective function, which
integer value lies furthest from the origin
- Solution is dependent on the quality of the input data (complete, accurate and valid)
- Only one quantifiable objective can be satisfied. Non-quantifiable objectives are not
considered at all
- Single value estimates (e.g. expected values) can be used for uncertain variables
- Only two "products" for graphical solution

6.4. Further considerations

Shadow price
Example
Following on from Activity 4, only 100 hours of unskilled labour are available.
Solving Activity 4 using linear programming demonstrated that the maximum contribution
that can be generated each week is $900 if 20 tables and 20 benches are made. Additional
unskilled labour hours may be available at a premium rate.
Required: Calculate the shadow price of unskilled labour.
 The objective function to maximize contribution (C) given by: C = 35x + 10y
Subject to constraints
- Materials 3x + 2y ≤ 120
- Skilled labor 5x + 2y ≤ 140
- Unskilled labor 4x + y ≤ 101
- Non-negative x ≥ 0, y ≥ 0
Solving simultaneously: x = 20.67; y = 18.32
Contribution becomes (20.67 x $35) + (18.32 x $10) = $906.65
Compared to a contribution of $900 when only 100 hours of unskilled labor were available,
this means that the availability of 1 additional hour of unskilled labor increases contribution by
$6.65. This is the shadow price of unskilled labor.
Slack: the difference between maximum resources available and resources used at the
optimal point. For binding constraints, the value of slack is zero
Example
Required: Calculate the slack for materials, unskilled labor & skilled labor in Activity 4
Let x = number of tables made per week. At the optimal point, x = 20. Let y = number of
benches made per week. At the optimal point, y = 20.
For each of the inputs, the slack is calculated as the maximum available less the use of the
resource in making 20 tables and 20 benches:
- Materials = 120 kg − (3x + 2y) = 120 − (60 + 40) = 20 kg
- Skilled labour = 140 hours − (5x + 2y) = 0
- Unskilled labour = 100 hours − (4x + 1y) = 0
The slack for skilled and unskilled labour is zero. This is as expected as they are binding
constraints. The slack for materials is 20 kg meaning that each week the company would use
20 kg less than the maximum available supply.
Slack may also relate to demand. If there is a limit to demand for a particular product (say
Product X), this would be included as a constraint in formulating the linear program. Having
solved the linear program and determined the optimal production of products, it may be that
the production of Product X is below the maximum demand. In this case, there will also be
slack.
This slack can be expressed in units as:
Maximum demand for Product X − Output of Product X
- If the amount of slack for a particular resource is low, there is a danger that the resource
could become a binding constraint if the availability of other scarce resources increases.
 Management may, therefore start to plan for additional supplies of the resource before
they are needed.
- If slack is high, it means that the availability of the resource exceeds the amount used by
a significant amount. It may be possible to use this resource elsewhere in the business or
sub-contract it to another business.
More than two variables => methods: the dual problem; simplex
CHAPTER 7: PRICING
7.1. Cost-based pricing approaches
Full cost plus pricing
- Long-term pricing strategy
- Ensures that prices cover all variable and fixed costs
$/unit
Direct production costs x
Absorption of overheads x
Variable production over head x
Fixed production overhead x
Variable non-production overhead x
Fixed non-production overhead x
Full cost x
Mark-up percentage x
Selling price x

SELLING TOTAL BUDGETED + TOTAL BUDGETED + MARK-UP

PRICE PER PRODUCTION COST NON-PRODUCTION
UNIT = COST
BUDGETED SALES UNITS
Marginal cost plus pricing: short-term pricing decisions
$/unit
Direct production costs x
Absorption of variable overheads x
Variable production over head x
Variable non-production overhead x
Marginal cost x
Mark-up percentage x
Selling price x

SELLING BUDGETED VARIABLE + BUDGETED VARIABLE + MARK-UP

PRICE PER PRODUCTION COST NON-PRODUCTION COST
 UNIT = BUDGETED SALES UNITS
Return on Investment (ROI) pricing: long-term pricing method
SELLING PRICE BUDGETED FULL COST + (TARGET ROI% x CAPITAL EMPLOYED)
PER UNIT = BUDGETED SALES UNITS
Opportunity cost pricing: short-term strategy used to price
- One-off projects
- Special orders
- Tenders for contracts
PRICE = RELEVANT COSTS + MARK-UP
 A relevant cost basis provided a MINIMUM PRICE that can be used as the basis
for a quotation
Activity 2
After spending $500 on market research, Bobco Engineering wants to bid on an important one-off
contract and needs to ensure its costing is both competitive and commercially rational. To
complete the project it will need to devote the following resources to its construction:
 1,500 kg of standard steel, which is regularly used in its production process. It currently
has inventory of 6,000 kg purchased at an average price of $8/kg. With recent market
conditions, the purchase cost is now $9.35/kg. *1,500 x $9.35
 500 kg of speciality steel. It has 500 kg of such steel in inventory. This was purchased 16
months ago at $12/kg. As it has not been used since purchasing, the auditors insisted on a
write-down to an estimated net realisable value of $4/kg *Book value = 500 x $4 => non -
cashflow. The purchasing manager figures that he can sell it for scrap at $2/kg *Scrap value =
$2 x 500. If sold, the cost to remove it from the warehouse and deliver it would be $1,000.
*Removal cost saved = $1,000
 380 hours of unskilled labour. Although the current trade union contract pays $6/hour for
such labour, extra workers would have to be hired in the "temporary" labour market at
$7/hour *380 x $7
 196 hours of semi-skilled labour paid $9/hour under the current trade union
contract. Currently, there is a surplus of such labour in the plant. *0
 51 hours of skilled labour paid $18/hour under the current trade union contract. The
workers are currently busy in another department, where they are producing output which is
sold for $96 and which uses $15 of direct material, $9 of skilled labour, $27 of semi-skilled
labour, $15 of variable overheads and $8 fixed-cost overheads allocated. It takes a half hour
of skilled labour to work on this existing product. The department head has agreed to release
his skilled workers but he must be compensated to be no worse off.
*Labor compensation + Contribution forgone = (51 x $18) + (51 x $60)
 *Lost revenue (per unit, given) 96
Less: Direct material (per unit, given) (15)
Skilled labor (per unit, given) (9)
Semi-skilled labor (per unit, given) (27)
Variable overheads (per unit, given) (15)
Fixed costs (not relevant) 0
Lost contribution per unit 30
Units per hour 2
Lost contribution per hour of skilled labor 60
 Use of equipment, which was scheduled to be disposed of this period for $12,000. If used
in the project, it will have to be disposed of later at an estimated selling price of $4,000.
*Reduced scrap value = 12,000 – 4,000 = $8,000
 Exclusive use of a piece of manufacturing equipment (a fibrillator), which will not
survive its use in the project. The machine originally cost $51,000 and currently has a
carrying (i.e. book) value of $6,000. It could now be sold in the used fibrillator market for
$8,000 (because new ones cost $45,000). If it was left in its existing use, it could generate
cash flows with an estimated present value of $5,000. *VIU = 5,000 < Deprival value = 8,000
 38 kg of Ecotox, which was originally purchased for $600/kg. Under current government
environmental rules, Bobco will have to pay $3,000 for the recycling company to take it away
if it is not used in the contract. *Saved disposal cost = ($3,000)
Required: Calculate the price which Bobco should bid for the contract on the assumption
that it wishes to charge a price equal to the relevant cost plus 25%.
$
Market research (sunk cost, therefore, not relevant) 0
Standard steel (regular use so replacement cost = 1,500 x $9.35) 14,025
Specialty steel (not used regularly, therefore, scrap value of 500kg x $2) 1,000
Less delivery costs (cost not incurred by using it) (1,000)
Unskilled labor (380 hours x $7) 2,660
Semi-skilled labor (surplus, work can be done in spare time) 0
Skilled labor: Direct cost (51 hours x $18) 918
Opportunity cost (51 x $60) 3,060
Use of equipment (reduced scrap value) 8,000
Fibrillator (deprival value) 8,000
Ecotox (saved disposal costs) (3,000)
Total relevant cost 33,663
Mark-up of (25%) ($33,663 x 25%) 8,416
Bid price 42,079
Lifecycle cost pricing
7.2. Economist’s model
Demand curve: the total quantity of a product or service the buyers in a market would wish to
buy in a given period
P = a – bQ
P – the price which would achieve a given demand, Q
a = price when Q = 0
b – the slope of the line – shows how much the price must change by to achieve a
given increase in demand
change in price
b=
change in quantity
Marginal revenue: the increase in total revenue resulting from selling one additional unit of a
product or service (doanh thu cận biên là phần doanh thu tăng thêm nếu bán thêm 1 sản phẩm)
 MR = a – 2bQ
Marginal cost: the increase in total cost from producing and selling one additional unit of a
product or service (chi phí cận biên là mức chi phí tăng thêm nếu sản xuất thêm 1 sản phẩm)
 TC = f + vQ
TC – total cost for the number of units produced, Q
f – total fixed costs
v – variable cost per unit
 MC = v
 Relevant in evaluating a decision to increase production and sales
Maximizing profits: MC = MR
7.3. Other pricing strategies
Market skimming: A high price is set initially (a large profit margin can be made), which
generally means that demand will be low. Later, when the early adopter segment of the market is
satisfied, the price may be lowered so that sales can be made to a larger market segment.
- To launch a new product into a market where there is no existing competition
- The product confers some status on the customer
- The product has a short lifecycle, and it is desirable to recover the development costs as
quickly as possible
Market penetration: A low price is charged initially to attract new customers (even lead the
manufacturer to make a loss). Once a customer base has been established, the price is increased
- For commodity-type products where there are many existing products available
- For price-sensitive products
- For products where economies of scale exist
Complementary product pricing: understand the impact that the price of one product may have
on demand for the other
Price discrimination: set different prices for a product or service in different markets
Loss leaders: are products that are sold at a loss to attract customers who will then buy other
products (i.e. supermarket promotions)
Going-rate pricing: charge the prevailing market price (i.e. homogeneous products that have
minimum variation (commodities such as aluminium or diesel))
Product-line pricing
 - Product bundling: a group of products are sold together for a price that is less than the
total of the individual products (i.e. fast-food restaurants: “meal deal”)
- Set differentials between different products in a range. For example, a price is set for a
basic car with a small engine, and other versions (e.g. a larger engine) are sold for the
basic price plus a pre-determined differential.
Volume discounting
Relevant cost pricing: one-off contracts or orders
7.4. Factors influencing pricing
Level of demand:
- Income - Consumer tastes and fashion
- Price of substitute goods - Advertising
- Price of complementary goods - Consumer views and capacity to pay
Price elasticity of demand (PED): the degree of sensitivity of demand for a good to changes in
the price of that good
%CHANGE IN DEMAND (Q) Q2−Q1
Q1
PED AT POINT 1 = =
%CHANGE IN PRICE (P) P 2−P1
P1

PED will generally be negative since a rise in price leads to a fall in demand. However, by
convention, the minus sign is ignored when describing PED (e.g. if calculated as "− 1.5", it is
described as "1.5").
Demand for a product can be described as:
- Elastic − meaning that demand is very responsive to changes in price
PED > 1.0, increasing the price may lead to reduced revenue
- Inelastic− meaning that a change in price will have little impact on demand
PED < 1.0, price rises can increase revenue (e.g. necessity goods)
Product lifecycle
- Introduction: price skimming or penetration pricing
- Growth: price skimming => price reduced, penetration pricing => price rise
- Maturity: profit maximization pricing policies
- Decline phase: lower prices may be charged to sell of excess inventories
Competitors
Customers
Perfect competition
CHAPTER 8: RISK AND UNCERTAINTY
8.1. Decision making in a world of risk
Risk: the existence of several possible outcomes, which are known in advance along with the
related probability
 Methods:
- Expected value - Maximax
- Value of perfect information - Maximin
- Decision trees - Minimax regret
Uncertainty: the potential outcomes of a decision that are not known in advance
8.2. Expected value (EV): represents the average outcome that would be achieved if a
decision were repeated many times
EXPECTED = WEIGHTED ARITHMETIC MEAN OF POSSIBLE OUTCOMES
VALUE (EV) = Σ (xi p(xi))
 The sum of the probabilities of all outcomes must equal to 1
Profit tables (payoff matrix)
Value of perfect information
VALUE OF PERFECT INFORMATION
= EV WITH PERFECT INFORMATION – EV WITHOUT PERFECT INFORMATION
Value of imperfect information
VALUE OF IMPERFECT INFORMATION
= EV WITH IMPERFECT INFORMATION – EV WITHOUT INFORMATION
Decision trees
- Decision fork (point)

- Chance fork (outcome point)

 Activity 4
Slim Foods is considering launching a non-sugar snack bar into a new market. Although the
company has not yet undertaken any market research, the marketing director estimates that the
product has a 60% chance of success and a 40% chance of failure in the market.
A market research company has offered to do research in the new market before the company
decides on whether to launch the product. Management believes there is a 60% chance the
market research will recommend the launch and a 40% chance it will advise Slim Foods not to
launch the product. The cost of the market research will be $30,000.
The market research company has admitted that its research findings do not always turn out to
be as expected once the product has been launched. The company advises that if it
recommends the launch, there would be an 80% chance the product would succeed and a 20%
chance it would fail. If it does not recommend the launch, there would be a 30% chance that
the product would succeed if management were to launch it and a 70% chance that it would
fail.
In all cases, if the product succeeded, the present value of future profits from the product
would be $10 million (excluding the market research costs). If the product failed, the net
present value of the loss would be $4.5 million (excluding the market research costs).
The company's directors are trying to decide whether to accept the market research company's
offer or make a decision based only on the gut feel of the marketing director.
Required
a. Draw a decision tree to illustrate the possible decisions and their associated potential
outcomes
b. Advise management how they should proceed
Expected present value of profits with market research
At outcome point G (launching), the EV is $7,100,000 (($10m*0.8) + (-4.5m*0.2)). This is
higher than zero (not launching), so the decision at point D would be to launch, and the EV
here is $7,100,000
At outcome point H, EV is - $150,000 (($10m*0.3) + (-4.5m*0.7)). This is less than not
launching the product, so the decision at point E is not to launch the product
Therefore, at outcome point B (market research recommendation), if the product launch is
recommended, it will be launched. If it is not recommended, it will not be launched. At the
outcome point B, the expected outcome is $4,260,000 (0.6*$7.1m + 0.4*0)
To get from point A to point B, the company has to pay $30,000 for market research.
$4,230,000
Expected present value of profits without market research
At outcome point F, the expected net present value of profits is $4,200,000 (($10m*0.6) + (-
$4.5m*0.4)). The decision at point C is therefore to launch, as the net present value of not
launching is zero. Therefore, the expected present value of profits at C is also $4,200,000
 No cost is involved in getting from A to C, so the expected net present value of profits is
$4,200,000 if market research is not carried out.
Conclusion: The market research should be undertaken. This is because the net present value
of profits is higher by $30,000 ($4,230,000 - $4,200,000) with market research
c. Calculate the value of the imperfect information provided by the market research
company
EV with the market research 4,260 (point B)
EV without market research 4,200 (point C)
Value of imperfect information 60

8.3. Risk attitude and decision rules

Three types of decision-makers
- Risk-seekers: maximum possible return
- Risk neutral: likely outcome
- Risk averse: make decisions based on the worst possible outcome, minimize potential
loss
Decision rules
MAXIMAX Select the alternative with the maximum possible payoff (i.e. the highest
return under the best case scenario). The risk seeker’s (i.e. optimist) rule
MAXIMIN Select the alternative with the highest return under the worst-case
scenario. The pessimist’s rule (i.e. risk averse)
MINIMAX Select the alternative with the lowest maximum regret. Regret is defined as
REGRET the opportunity loss from having made the wrong decision. Minimax regret
is also suited to investors that are adverse to missing out.
EXPECTED Select the option that gives the highest EV. Those who use Evs may be
VALUE (EV) described as risk neutral (i.e. they are not concerned with the amount of risk
associated with each option, only the amount of the expected return)

8.4. Sensitivity analysis

Sensitive analysis: calculates how responsive a decision is to changes in any of the variables
used in making that decision
SENSITIVITY % = PROFIT + VARIABLE
 Look at 1 VARIABLE at a time
Simulation: a mathematical model constructed to represent the operation of a real-life process or
situation
 Allow MORE THAN 1 VARIABLE to change at the same time
8.5. Reducing uncertainty
Focus groups: used before the launch of a product
Market research: the systematic gathering of information about customers, competitors and the
market; and can be based on primary or secondary data
CHAPTER 9: BUDGETARY SYSTEMS AND TYPES OF
BUDGET
9.1. Objectives of a budgetary control system:
C R U M P E T
Coordinatio Responsibility Utilization Motivation Planning Evaluation Telling
n
9.2. The performance hierarchy
Long-term planning: Mission => Strategic objectives => Business unit objectives
Master budget
Functional budgets
- Profit center: revenues + expenditures
- Investment center: a profit center + capital expenditure (investment in assets)
9.3. Different types of budgetary systems
Top-down vs Bottom-up budgeting
 Budgetary slack: is the intentional underestimation of budgeted revenues or overestimation
of budgeted costs to make budgets easier to achieve
Top-down Bottom-up
(participative budgeting)
senior management lower-level managers
Suitable for • Lower-level employees have no interest Companies where individual
in participarting in the process department could set-up their own
• Employees are not technically capable budgeting
of participating in budget setting
• Information that is necessary for
budgeting
Advantages • Save time and costs • Improved management morale
• Managers may not have the skills or • Managers are more likely to
motivation to participate usefully in the accept the plans contained
budgeting process within the budget and strive to
• Senior have the better overall view of achieve the targets
the company and its resources • The lower level managers will
• No slack have a more detailed knowledge
of their particular part of the
business than senior managers
and thus be able to produce
more realistic budgets
Disadvantages • Middle managers may not be • Time-consuming and costly
motivated since they may think that • Slack
they are forced to agree the budget
• Limited involvement of middle
 managers would also raise the lack of
commitment in applying these budgets
Rolling budgets (rolling forecasts): a system of budgeting in which the budget is continuously
updated
 MOST appropriate in industries which are DYNAMIC, where external changes can lead
to the original budget quickly becoming out of date (i.e. manufacturers of computer devices
and mobile phone; airlines, advertising agencies, etc). NOT STABLE INDUSTRIES.
Incremental budgeting: is prepared based on the previous period’s budget or actual
performance, with incremental amounts added for the new budget period
 STABLE BUSINESS WITH GOOD CONTROL
Zero-based budgeting (ZBB)
1. Each manager identifies activities to undertake in the budgeted period. A "decision
package" is then prepared for each activity that analyses how much will need to be spent.
There also may be some narrative explaining the benefits of the package and quantifying
any revenues (or cost savings) if appropriate.
2. A budget committee reviews and ranks all the decision packages (in decreasing order of
benefits). Management accepts each package up to the point at which the total budgeted
expenditure is reached.
3. Resources are allocated to the activities selected in Step 2. The budget is then a
consolidation of all the accepted packages.
Activity-based budgeting (ABB)
1. Estimate the budgeted volume of sales and production in units.
2. For each activity (e.g., machine set-up), estimate the number of driver units required to
support the budgeted sales and production volume (e.g., the number of production runs).
3. Determine the cost of each unit of driver. This may require an analysis of factors such as
labour time required, labour cost per unit, etc.
4. Calculate the budgeted cost of each activity (number of drivers × cost per unit of driver).
 USED ONLY IN LARGE COMPANIES: high overheads; many different activities
(drivers) to which the overheads relate; many products with different production times
and methods
Feedback and Feed-forward control
- Feedback control system: i.e. budgetary control system
- Closed-loop system: any system with feedback
o Standard: What the system aims for (e.g. the budget)
 o Sensor: Measures the system's output (i.e. accumulation of actual data)
o Comparator: Compares the information from the sensor to the standard (e.g. variance
analysis)
o Effector: Control action (e.g. management action to minimise future adverse
variances and repeat favourable variances)

- Open-loop system: without feedback

- Positive and negative feedback: the output has achieved/exceeded/below the plan
- Feed-forward control: predicted future results are compared against the desired
outcome. If it appears that the desired result will not be achieved based on the current
prediction, action can be taken now so that it is achieved. (e.g. target costing: the
 expected cost per unit is compared with the derised cost per unit, and action is taken
to eliminate the gap)
Advantages Disadvantages
Incremental • The system is relatively simple to operate • Gives no incentive for developing
budget and easy to understand new ways of working or
• Avoid conflict between departmental reduction of costs
managers since a consistent approach is • Manager may spend
adopted throughout the organization unnecessarily to use up their
• Coordination between budgets is easier to budgeted expenditure to receive
achieve, as increments in functional the same/higher budget in next
budgets are easily aggregated into master year
budgets • The budget may become out of
• The effect of change can be seen quickly date and no longer relate to the
level of activity or type of work
being carried out
• The priority for resources may
have changed
• Any budgetary slack and
inefficiencies in a previous
budget is not reviewed
ZBB • Forces budget setter to re-evaluate every • Time-consuming, require high
activity. Obsolete activities are removed. level of skills (cost > benefit)
Wastage and budget slack should be • Ranking the packages can be
eliminated. difficult since many activities
• Develops a questioning attitude and cannot be compared based purely
encourages managers to look for on quantitative measures
alternatives • Too rigid and organization may
• Encourages a bottom-up approach to not able to react to unforeseen
budgeting => boost motivation of opportunities or threats
employees • Short term benefit > detriments
• Prevents “budget creep” (based on previous of long term goal
year’s figures with a percentage add-on)
Rolling • The budget is continuously updated to • Time, effort and money
budget reflect external changes, making it more • Budgets may be changed to hide
relevant and valid for comparison against operational inefficiencies
actual performance
• There will always be a budget for the next
12 months. This can be useful for planning
things such as cash flows and controlling
• Managers will be more motivated as the
budget is more realistic because it will be
updated to take account of changes outside
of their control
ABB • Draws attention to the costs of ‘overhead • Complicated and expensive to
activities’ which can be a large proportion implement as it requires detailed
of total operating costs analysis of overheads and
• A better understanding of what causes costs measuring of activities
to be incurred may provide opportunities • As fixed costs do not vary with
 for cost reductions. changes in the volume of drivers
• May identify “non-value adding” activities in the short run, ABB may
which can be eliminated provide misleading information
9.4. Information used in budgetary systems
Aspects of information quality

A C C U R A T E
Accurate Complete Cost- User- Relevant Authoritative Timeliness Easy to
effective focused use
Sources of data and information: internal, external
9.5. Difficulties of changing a budgetary system
- Resistance to change: employees who do not appreciate the value of change may be
reluctant to help, especially if it requires additional work.
- Scepticism: particularly at senior management levels. Managers who do not understand
the benefit of the change may not give their full support.
- Training everyone involved in the process of change.
- Additional time and costs involved in moving to a new system
9.6. Uncertainty in the environment
Forecasting
- Factors may cause uncertainty in the budget-setting process:
o overall economic performance of the markets
o actions of competitor
o performance of employees
o market prices of inputs
o demand for new products will be uncertain
- Methods:
o Flexed or flexible budgets
o Rolling budgets
o Revision of the budgets at the end of the period before comparing with actual results
Flexible budgets: involves preparing two or more budgets, using different assumptions for each
about the level of sales or production
TOTAL COST = FIXED COST + (VARIABLE COST x ACTIVITY LEVEL)
 High-low method or Learning curve
Flexed budgets: At the end of the year, prior to comparing the actual figures against the budget,
the budgets are re-calculated (flexed) using the original budget assumptions, but the actual
activity levels
9.7. Behavioral aspects of budgeting
Hopwood’s management styles
- Budget-constrained style
- Profit-conscious style
- Non-accounting style: qualitati ve factors are more important (e.g. customer satisfaction)

Setting the level of difficulty of the budget

- Targets can be used to motivate employees
- If individuals have higher levels of intended achievement, their actual achievement rises
Benefits and difficulties of employee participation
9.8. Beyond budgeting
Criticisms of traditional budgeting
- Budgets take up too much time
- Traditional budgeting is irrelevant in the modern business environment
- Dysfunctional behavior
Beyond budgeting model
 - Replace financial targets with targets based on key performance indicators (KPI)
- Appraise managers and reward them accordingly
- Devolve responsibility for planning away from the center
- Manage resources to be available for worthwhile opportunities
- Control performance rather than just relying on comparison of actual performance
against the budget
Evaluation of beyond budgeting
- Advantages
o Divisional managers will be more motivated as they will be given autonomy to plan
for their own business units
o Create a climate based on competitive success
o Faster response to changes in customer needs as managers can react quickly to new
threat and opportunities rather than adhere to an outdated budget
o Performance is focused on KPIs that reflect the organization’s overall objectives
o More customer-focused attitude
- Disadvantages
o The organizational culture may not support this approach (e.g. command-and-control
style of management)
o May not be appropriate in organizations in which financial control is crucial to
success (e.g. in public sector where funds are limited)
CHAPTER 10: ANALYTICAL TECHNIQUES
10.1. Forecasting methods
Simple average growth models
Example
The sales of Beta during the last three years were as follows
Year Sales in $000
20X2 100
20X3 180
20X4 210
20X5 300
The growth rate of sales each year is as follows:
20X3 80% (180 – 100)/100
20X4 16.67% (210 – 180)/180
20X5 42.9% (300 – 210)/210
The average growth rate is √ 1.8∗1.1667∗1.429 = 1.442 = 44.2%
3

 This can then be used to calculate expected sales in future periods

High-low method: estimate the fixed and variable elements of a semi-variable cost
10.2. Time series analysis
Components of a time series
Y=T+S+C+I
Trend (T): underlying long-term movement in values over time
Seasonal variations (S): short-term fluctuations in value caused by differing circumstances
affecting results at different times of the day, week, month, year, etc.
Cyclical variations (C): medium-term changes in values resulting from factors that repeat in
cycles (e.g. economic cycle – the alternation between booms and recessions)
Random variations due to non-recurring influences (I)
Identifying the trend
 MOVING AVERAGES METHOD: removes seasonal variations from data by averaging
- Odd subset: sum the figures for each period => divide by the number of periods
- Even number: sum => divide => average the computed figure again
Identifying the seasonal variations
 ADDITIVE MODEL: Y =T+S+C+I
(Short-term, ignoring C): Y = T + S, therefore S = Y – T
 MULTIPLICATIVE MODEL: Y = T x S, therefore S = Y/T
Seasonally-adjusted (“deseasonalized”) data
 - For the additive model: subtract positive variations from actual data and add negative
variations to actual data
- For the multiplicative model: divide actual data by the seasonal variation factors
Forecasting using time series analysis
- Step 1: Tính seasonal variation
- Step 2: Tính trung bình chênh lệch
o Chênh lệch tuyệt đối (additive model): S = Actual – Trend
o Chênh lệch tương đối (multiplicative/proportional model): S = Y/T
- Step 3: Điều chỉnh tổng chênh lệch
o Additive model: tổng seasonal variation = 0
o Proportional model: tổng seasonal variation = tổng số item trong 1 chu kì
10.3. Correlation and regression
Correlation: the closeness of the relationship between two or more variables
- Positive correlation - Perfect correlation
- Negative correlation - Zero correlation
Correlation coefficient (r)

The value of the correlation coefficient will always lie between −1 and 1
r = +1 perfect positive correlation (i.e. all points on an upward sloping straight line)
r = −1 perfect negative correlation (i.e. all points on a downward sloping straight line)
r=0 means the variables are uncorrelated (i.e. no linear relationship)
Coefficient of determination (r2): explains how much of the total change in the amount of one
variable can be explained by the change in the other variabe
Regression:
- Assumes a lineare relationship between variables
- Described by equation y = a + bx
10.4. Learning curve theory
The learning effect
- Starts from the production of the first unit/batch
- Each time cumulative production doubles, the cumulative average time per unit falls
to a fixed percentage of the previous average time
Tabulation
Example
A product will take 100 hours for the first unit, and an 80% learning curve applies.
Required: Complete the following table
Unit Cumulative average time Cumulative total time Incremental total time
s
1 100 100 100
2 80%*100 = 80 160 60
4 80%*80 = 64 256 96
8 80%*64 = 51.2 409.6 153.6
16 80%*51.2 = 40.96 655.36 245.76

Required: Calculate the cumulative average time to product 10 units?

y = axb = 100*10-0.3219 = 47.65 hour
Learning curve formula

y = axb
y – cumulative average time per unit to produce x units
a – time taken for the first unit of output
x – the cumulative number of units produced
b – the index of learning (logLR/log2)
LR – the learning rate as a decimal
Conditions for a learning curve to apply
- The activity is labor intensive
- The units are identical (i.e. a repetitive task)
- Low labor turnover
- No prolonged breaks in production
Applications of learning curve theory
- Standard setting – labor standard should be set/revised based on the expected learning
effect
- Budgeting – variable costs per unit are expected to fall with an increase in production
- Pricing decisions – an accurate labor cost may be predicted
- Work scheduling
Reservations about the learning curve
- Knowing what the learning rate will be for new products
- Useful when a product’s production occurs continuously. If there is a break in
production, workers may “forget” the skill and the learning curve will not be so
predictable.
- Many products are tailor-made for customers so the mass production on identical items,
on which the learning effect is based, is not always appropriate
- In some heavily unionized industries, there may be “go slow” agreements where
workers agree not to work to their full capacity to save jobs
Steady state
 In practice, the learning curve effect does not continue forever. At some point, a “steady
state” is reached; beyond this point, the time taken per unit is constant
INCREMENTAL TIME PER UNIT (STEADY STATE)
= TOTAL TIME (ALL UNITS AT SS) – TOTAL TIME (ALL UNITS BEFORE SS)
 Steady state is achieved when the incremental time per unit is constant
 Even after steady state is reached, the cumulative average time per unit would
still be decreasing
Example
 Drake Co is budgeting the labour hours it needs to produce its new product, the Rega.
Drake Co estimates that the learning rate of its workforce on this production is 85%, and that
steady state is reached on the 20th unit.
The index of learning b is given as −0.2345. The time taken to produce the first unit is 2 hours.
Required: Calculate the incremental labour time per unit for the 20th and subsequent
units.
Hours
Total time taken to make the first 20 units (20*2*20-0.2345) 19.81
Total time taken to make the first 19 units (19*2*19-0.2345) 19.05
Time taken to make the 20th and subsequent units 0.76
The 20th unit took 0.76 hours to produce. This would apply to all units produced after the 20th
unit. For example, if total production was 100 units, the total labor hours would be:
19.81 hours (total time to make 20 units) + 80*0.76 hours (steady state incremental time per
unit) = 80.61 hours
Estimate the learning rate
- Tabular approach
Example
Foxy Co makes personal computers. The components for the PCs are bought from various
manufacturers, and the factory workers at Foxy Co assemble these to make a finished PC.
Production of a new type of PC has just begun. The management accountant has asked a
worker to keep a record of how much time they took to make each new computer. The worker
provided the following summary for the first month:
Incremental time taken (minutes)
1st unit 340
2nd unit 204
3rd and 4th units 326
5th to 8th units 522
9th to 16th units 964
17th to 32nd units 1,928
Total 4,284
The time shown within each band is the total for that band, not the average per computer.
Required:
a. Calculate the learning rate that applied to the new PC
 Cumulative output Cumulative total time Cumulative average time per unit
(units) (minutes) (minutes)
1 340 340
2 544 272
4 870 217.5
8 1,392 174
16 2,356 147.25
32 4,284 133.875
As cumulative output doubles:
From 1 to 2 units: 272/340 = 80%
From 2 to 4 units: 217.5/272 = 80%
Therefore, the learning rate appears to be 80%.
b. Estimate the point at which the learning period finishes
Incremental time taken Average incremental time
1st unit 340 340
2nd unit 204 204
3rd and 4th units 326 163
5th to 8th units 522 130.5
9th to 16th units 964 120.5
17th to 32nd units 1,928 120.5
The time taken per unit becomes constant at 120.5 from the start of the band that includes the
9th to the 16th unit.
Therefore, the learning effect ends after the 8th unit.
- Algebraic approach: MUST BE USED when only information about the cumulative
average time is for two levels of output that are not exponentials of 2
 MIGHT BE CASE IN OTQ
Example
The first unit of a product took 300 minutes; the total time taken for the first 8 units was 2,056
minutes.
Therefore, the cumulative average time per unit for the first 8 units is 257 minutes (2,056/8).
Cumulative output has doubled three times since the production of the first unit (from 1 to 2,
to 4, then to 8), and the cumulative average time per unit has fallen to 257. If the learning rate
 is r:
Then, 300 × r3 = 257
So, r3 = 257/300 = 0.8567
Therefore, r = 0.9497 i.e. approximately 95%
 It is potentially confusing that a HIGHER LEARNING RATE means the EFFECT
of learning is LOWER
 Several developments may have reduced the learning effect and led to a higher
learning rate
- The introduction of technology means that the processes are less labor intensive.
There is, therefore, less scope for learning, as much of the process is likely to be
automated anyway and automated processed are likely to work at a constant rate.
- The recent redundancies may have demotivated the remaining staff members, as
they may believe that the company has little loyalty towards them. When morale is
low, employees are less likely to work as productively as possible, leading to a
higher learning rate.
CHAPTER 11 + 12: STANDARD COSTING & BASIC VARIANCE
ANALYSIS
[F2 REVISION]
STANDARD COSTING
- Standard cost: is a planned or predetermined cost which indicates how much a unit of
a product or service SHOULD cost
- Standard costing: is a control technique because it involves comparing standard
(expected) costs with actual costs and calculate their differences
- Standard type: basic standard, ideal standard, attainable standard, current standard

APPLYING STANDARD
SALES VARIANCES
Actual quantity sold x Actual price (AQ AP) Price variance
(shows the effect on profit of selling at a
Actual quantity sold x Standard price (AQ SP)
higher/lower price than the standard)

Actual quantity sold x Standard margin (AQ SM) Volume variance

(BQ SM) (shows the effect on profit on selling
Budget quantity sold x Standard margin
more/less than the budgeted quantity)
*Margin = contribution per unit (marginal costing) or profit per unit (absorption costing)
MATERIALS VARIANCES
Actual quantity purchased x Actual price (AQ AP)
Price variance
Actual quantity purchased x Standard price (AQ SP)

Actual quantity used x Standard price (AQ SP)

Standard quantity used x Standard price (SQ SP) Usage variance
(for actual production)
LABOR VARIANCES
Actual hours paid x Actual labor rate (AH AR) Rate variance
Actual hours paid x Standard labor rate (AH SR)
Standard hours worked x Standard labor rate (SH SR) Efficiency
(for actual level of production) variance
Idle time variance = (Actual hours paid – Actual hours work) x Standard cost per hour
VARIABLE PRODUCTION OVERHEAD VARIANCES
 - Assume that variable overheads are incurred during productive labor hours only (i.e.
hours worked)
Actual hours worked x Actual variable overhead rates (AH AR) Expenditure variance
Actual hours worked x Standard variable overhead rates (AH SR)
Standard hours x Standard variable overhead rates (SH SR) Efficiency variance
(for actual production)
FIXED PRODUCTION OVERHEAD VARIANCES
Fixed overhead expenditure variance: only variance in marginal costing
Actual fixed cost X
- Budgeted fixed cost X
Fixed production overhead expenditure variance X/(X)
Fixed overhead volume variance: absorption costing
Actual production X
- Budgeted production X
Difference X
x Standard fixed overhead rate per unit X
Fixed overhead volume variance X/(X)
- Capacity variance: compares actual labor hours worked with the original budget
Actual labour hours X
- Budgeted labor housr X
Difference X/(X)
x Standard rate per hour X
Fixed overhead capacity variance X
- Efficiency variance: compares actual labor hours worked with the standard labor hours
for actual output
Actual labour hours X
Standard hours for actual output X
Difference X/(X)
x Standard rate per hour X
Fixed overhead efficiency variance X
 When calculating usage and efficiency variance: use ACTUAL USAGE, not the actual
purchases & compare to the STANDARD USAGE FOR ACTUAL OUTPUT, not the
original budgeted usage
A RECONCILATION
 - Unless explicitly told otherwise, assume that all inventories (raw materials and finished
goods) are stated at standard rather than actual cost
Absorption costing Marginal costing
Budgeted profit (BQ x standard profit per unit) Budgeted contribution
+/- Sales variances (price, volume) +/- Sales variance
Standard profit on actual sales Standard contribution on actual sales
+/- Materials price/usage +/- Materials price/usage
+/- Labor rate/idle time/efficiency +/- Labor rate/idle time/efficiency
+/- Variable overhead rate/efficiency +/- Variable overhead rate/efficiency
+/- Fixed overhead expenditure/capacity/efficiency
Actual gross profit Actual contribution
+/- Non-production overhead +/- Fixed production overhead
+/- Non-production overhead
Actual net profit Profit for the period

Actual profit (MC) X

Finished goods inventory at MC X
Finished goods inventory at AC X
X
Actual profit (AC) X
 If finished goods inventory is increasing, AC will show a higher profit than MC
- If inventory were valued at its actual cost
Sales X
Costs (X)
Closing inventory X
Actual profit X

CAUSES OF VARIANCE
Favorable Adverse
Materials price Bulk discounts Market price increase (shortage)
Different Bad purchasing
supplier/materials Delivery costs
Change in quality
Materials usage Better quality Defective material
Different batch sizes More efficient Theft
Change in mix Excessive waste or spoilage
Stricter quality control
Labor rate Lower skilled labor Wage rise
Different skill mix Overtime working
Bonus payment
Idle time Strikes
Lack of material
Breakdowns
Injury/illness
Lack of orders
Labor efficiency Positive motivation Negative motivation
Higher pay/skill Lower pay/skill
Better equipment Poor equipment/material
Learning effect Slow working
Better material
Overhead expenditure Cost savings/cutbacks Cost increases
Incorrect split of semi- Excessive service usage
variable and fixed costs
Overhead efficiency
Overhead capacity Increase in productive hours Excessive idle time
Shortage of plant capacity
Sales price Market shortage To achieve an increase in volume
Change in quality
Response to
competitors
Pass on cost changes
Sales volume Increase in market share/size Fall in market share/size
CHAPTER 13: ADVANCED VARIANCE ANALYSIS
13.1. Materials mix and yield variances
Material usage variance = Material mix variance + Material yield variance
A mix variance is used to monitor the cost of material by looking at the change in the cost of
materials when the input materials are used in different proportions to the set standard
Actual quantity, Actual quantity,
Difference Variance
actual mix (AQ AM) Standard mix
liters/kg liters/kg liters/kg $
A B (A – B) (A – B) x Standard cost
Material 1
Material 2
A yield variance measures the efficiency of turning the inputs into outputs
The ‘total’ method Units
Actual output (in units) A
Exptected outputs from actual input (in units) B
Difference (A – B)
x standard cost per unit
Yield variance x
The ‘individual’ method
AQ SM SQ SM Variance
liters/kg liters/kg liters/kg $
A B (B – A) (B – A) x Standard cost
Material 1
Material 2
Interpreting material mix and yield variances
- A favorable overall materials mix variance means the actual mix is cheaper than
standard mix. Cheaper materials have been substituted for more expensive ones.
- A favorable yield variance means that actual output exceeds the output expected
for the given input units. This could be due to:
o Less spillage due to production methods
o Less waste due to quality of materials used as inputs
Inter-relationship between price, mix and yield variances
- The materials price variances may be outside the control of the production manager
- A manager who creates a favourable mix variance using an increased proportion of less
expensive material may inadvertently cause an unfavourable yield variance
  A favorable mix and yield variance may result in an unfavorable non-financial impact
13.2. Sales mix and quantity variances
- A sales mix variance: indicated the effect on profit of changing the mix of actual sales
from the standard mix
Produc Actual sales quantity, Actual sales quantity, Differen Standard Variance
t Actual mix (AQAM) Standard mix (AQSM) t margin
A B A-B C (A – B) x C
X
Y
Z
- Sales quantity variance: indicates the effect on profit of selling a different total quantity
from the budgeted total quantity
Produc Actual sales quantity, Budgeted sales quantity, Differen Standard Variance
t Standard mix (AQSM) Standard mix (BQ DM) t margin
A B A-B C (A – B) x C
X
Y
Z
Interpreting the sales mix and quantity variance
- Analyzing the sales volume variance into mix and quantity variances is only likely useful
when sales of the various products are interrelated
- The analysis may indicate that products are substitutes or complements
- An adverse mix variance means that customers are buying less of the higher-margin
products and are instead buying lower-margin products. It implies substitution of one
product for another, rather than a reduction in the overall quantity of products sold
- An adverse quantity variance may be due to poor economic conditions or a new
competitors
 Inter-relationships between variances
o Sales price and sales volume variances: a fall in selling prices for products would lead
to an adverse price variance. However, if it also leads to higher demand for the
products, the volume variance would be favorable.
o Sales mix and quantity variances: an adverse sales mix variance may be due to
customers switching to cheaper ranges or brands as these may be considered better
value. If these “better value” products attract customers from other products too, this
will lead to a favorable quantity variance
CHAPTER 14: PLANNING AND OPERATIONAL VARIANCES
14.1. Revision of budgets and standards
- At the end of a budget period, before comparing an organization’s actual performance
against the budget, budgets may be revised to take account of environmental changes
that were not anticipated when the budget was prepared
- Principles
o If something occurred during the budget period that was outside the control of the
manager meant the budget became unrealistic, the original budget should be revised
o Management should NOT revise budgets to hide inefficiencies
o Senior management should approve only appropriate revisions
14.2. Planning and operational variances
Problems of traditional variance analysis
- Compares: ACTUAL PERFORMANCE vs. EXPECTED PERFORMANCE
- Operational variance: revised budget vs. actual results
- Planning variance (or budget revision variance): revised budget vs. original budget
Planning cost variances
Materials price and labor rate
- Traditional price/rate variance: (AQ AP) (AQ SP)
Planning price variance Operational price variance
Actual quantity x Original standard price x Actual quantity x Actual price x
Actual quantity x Revised standard price x Actual quantity x Revised standard price x
Planning price variance x Operational price variance x
Adverse if the revised standard price is Favorable if the actual price is less than the
higher than the original standard price revised standard price
Materials usage and labor efficiency
- Traditional usage/efficiency variance: (AQ used – BQ for actual production) x Std cost
Planning price variance Operational price variance
Original std quantity for actual output x Actual quantity used x
Revised std quantity for actual output x Revised std quantity for actual output x
Difference x Difference x
@ original std price/rate per unit/hour x @ original std price/rate per unit/hour x
Material usage/Labor efficiency x Material usage/Labor efficiency x
planning variance operational variance
 Adverse if the revised std quantity is greater
than the original std quantity
Learning curve and labor variances
Market size and market share variances
- A market size variance: arises because the size of the market was different from
expected due to change in the external environment (e.g. economic growth)
- A market share variance: arises because the share of that market was different from the
budget (e.g. due to effective advertising)
 Sales managers can control the market share variance but cannot control the market
volume variance. Therefore, any bonus for the sales manager should be linked to the
market share variance.

Market size variance Market share variance

Budgeted sales quantity x Actual sales quantity x
Revised budgeted quantity x Revised budgeted quantity x
(Actual market size x Budgeted market share)
Difference x Difference x
@ Standard margin per unit x @ Standard margin per unit x
Market size variance x Market share variance x
Advantages and disadvantages
Manipulation: Managers who have not achieved their budgets/targets may try to hide adverse
variances by revising their budgets and standards. Therefore, to prevent manipulation, there must
be strict rules to ensure that budget revisions are only made when appropriate. Revisions should
only be permitted when there is independent, verifiable evidence (e.g. a published price index for
a change in market price).
14.3. Behavioral aspects of standard costing
Effect on staff motivation and action
Variances and performance evaluation
- Identify the cause of the variance & whether other variances were also affected
(For example: A favorable materials price variance may have been caused by buying
cheaper materials, but this also have resulted in an adverse material usage variance)
 Variances that are related to a common factor should be evaluated together
- Identify who is responsible: Managers should ONLY BE JUDGED on variances that
are WITHIN THEIR CONTROL
o Materials price variance – the purchasing department. However, look for signs that the
purchasing department may have been put under pressure to buy from a particular supplier.
Or, if the purchase was requisitioned at very short notice, the purchasing department may
have been unable to obtain a favourable price that it might have had otherwise.
o Labour rate variances – this depends on who decides how much to pay particular workers. It
could be the human resources department or the factory manager.
o Labour efficiency variances are usually assumed to be the responsibility of the person who
supervises the workers – this could again be the factory manager. However, these variances
may also be related to the rate variance – a higher grade of labour will generally lead to an
adverse rate variance, but the labourers might work more efficiently.
o Material usage variances are also associated with a production manager. However, variances
may also have been caused by the purchase manager buying a quality of material different
from the standard.
o Mix and yield variances are typically controlled by the production manager, who supervises
the production process. However, these may also be affected by the quality of materials used,
which could be the responsibility of the purchasing manager.
o Overhead variances will be the responsibility of the appropriate managers – equipment
maintenance expenditure, for example, would depend on the maintenance manager.
- Consider whether the standard was fair: operational variances are generally a more
reliable indicator of performance than traditional variances
- Non-financial factors: variances reflect only the financial view. Non-financial factors
such as quality may be equally important, but these factors are ignored by variances.
 For example: A past exam question involved a company that manufactured soup. The
production manager had been told that his performance would be judged on the reported
 variances. He had successfully kept costs down, reporting large favourable mix and yield
variances. From a financial point of view, this seemed positive.
On the other hand, the sales manager was angry that customers were complaining about
the quality of the soup. This was related to the production manager diluting the soup to
reduce costs, which also reduced quality. In the long term, this threatened to lead to a fall
in demand, leading to a fall in profits.
- Improving future performance
 For example:
o Including non-financial factors as well as variances in managers’ appraisal systems
o Regular review and updating of variances to reflect changes in the external
environment
o Using target costing to identify ways to reduce costs further
Relevance of variances in the modern environment of JIT and TQM
- Variance analysis is not relevant in the modern, rapidly changing business world and it
can lead to dysfunctional behavior
o Overemphasis on quantitative elements of performance
o JIT and flexible manufacturing systems aim to provide more tailored production and
there may be less standardization of production which makes comparison with a
standard less meaningful
o JIT purchasing systems: input costs will likely be known with certainty in advance, so
no price variances
o Traditional standard setting based on a company’s own costs and procedures which
may be too inward-looking
- A more modern approach is benchmarking, which also takes into account the practices of
other organizations in the industry (i.e. external information)
Behavioral problems in rapidly changing environment
- Merely meeting standards may be insufficient to ensure a company’s survival in a
competitive environment. It may be necessary to focus on trends in variances which aim
for continual improvement.
- Standards provide an internal focus to management. In a rapidly changing environment,
an external focus would be more appropriate.
- New products come online more frequently. There may be learning curves associated
with these. Standards which fail to reflect learning curves may not set an appropriate
target. They could be too easy, which would not challenge staff, or too difficult, which
would be demotivating.
CHAPTER 15: PERFORMANCE MEASUREMENT
15.1. Objectives of performance measurement
Main objectives
- Design measures consistent with the strategy for each level of the organization
- Set objective, quantifiable targets rather than subjective appraisal
- Develop reward schemes based on managers’ performance against the targets
- Judge managers fairly, i.e. on outcomes they control
The performance hierarchy
- Mission: the main reason for the existence of the organization
- Corporate objectives
- Subsidiary objectives
- Unit objectives
15.2. Financial Performance Indicators (FPIs)
Returns on capital (tỷ suất sinh lời trên vốn)
RETURN ON EQUITY PROFIT AFTER TAX
x 100
(ROE) = SHARE CAPITAL + RESERVES

RETURN ON CAPITAL PROFIT BEFORE INTEREST AND TAX

x 100
EMPLOYED (ROE) = CAPITAL EMPLOYED
 CAPITAL EMPLOYED = TOTAL ASSETS – CURRENT LIABILTIES
= TOTAL EQUITY + LONG-TERM DEBT
 It is important to match the profit with the appropriate capital.
o If profit is after interest, divide by equity
o If profit is before interest, devide by equity + long-term debt
- ROCE shows the return generated on the long-term capital invested in the company. This
can be compared with other companies in the same industry sector or to the company's
cost of capital.
- Comparing companies in other sectors does not provide valid information. Service
industries, for example, require less capital than manufacturing industries and will show a
greater return on capital employed for each dollar of profit.
 - ROCE is validly improved by investing in projects that generate a higher return on
capital. Other methods of increasing ROCE that are NOT actually improvements include:
o The use of different accounting policies may affect profits capital employed
o Delaying investment in new plant and machinery or reducing investment in intangible
assets. As the existing NCA depreciate, their carrying amount (net book value) falls,
reducing the capital employed and improving ROCE. Such measures may harm the
organization in the long term
Profit margins
Gross profit margin
GROSS PROFIT
GROSS PROFIT MARGIN = x 100
REVENUE
 Meaning
- A falling gross profit margin over time means that
o Either the selling price at which the company sells its goods is declining, or
o The cost of making or buying those goods is increasing, but those increases cannot be
passed on to customers
- In either case, a prolonged decline is a bad sign. It suggests that the company’s products
or services are losing popularity, which raises concerns for the viability of the
business.
- Gross profit margins may also reflect an organization’s pricing strategy
o Companies that use a premium pricing strategy are likely to have a high gross profit
margin
o Companies that aim to sell for a low price, to achieve a larger volume of sales are
likely to have a low gross profit margin
 Methods to improve
- Introducing new products that are popular with customers. These can be sold for a higher
margin.
- Using target costing to reduce the cost of sales.
NOT: Reclassifying direct expenses as administrative would increase the gross profit margin
but not improve overall profitability. Gross profit depends on the company's policy for
classifying expenses as direct or administrative. Changes in such policies should be viewed
with suspicion.
Net profit margin
NET PROFIT AFTER TAX
NET PROFIT MARGIN = x 100
REVENUE
 Meaning: Net profit, sometimes called “the bottom line”, shows overall profits (after
deducting all costs) as a percentage of revenue
- Although this gives a broad indicator of the organization’s performance, further analysis
should consider that the causes of changes must be investigated
- Net profit margin reflects the following three areas
o The underlying popularity of the company’s products and services (also reflected in
the gross margin)
o The amount of control the company has over administrative-type expenses
o Costs of debt financing. This will depend partly on whether the company has
changed the amount of debt and partly on whether interest rates have changed
 Methods to improve
- Introduce new products popular with customers. These can be sold for a higher margin
- Use target costing to reduce the cost of sales
- Increasing sales volume should increase net profit margins if a high portion of the
company’s costs are fixed (e.g. in a training company)
- Better control over administrative expenses (e.g. salaries)
- Using less debt finance
Asset turnover ratio
REVENUE
ASSET TURNOVER RATIO =
CAPITAL EMPLOYED
 Meaning: It indicates whether or not the capital invested is appropriate, given the value of
sales revenue. Excessive levels of capital invested will lead to a low turnover ratio
 Methods to improve
- Selling non-current assets that are surplus to requirements
- Recognizing impairments and writing down the value of the assets (merely financial
engineering as it does not improve actual performance)
- Improving working capital management, i.e. by collecting receivables more quickly or
reducing inventory levels through better inventory management\
 Analysis of ROCE
ROCE = OPERATING PROFIT MARGIN x ASSET TURNOVER
 Profit before interest and tax Profit before interest and tax Revenue
= x
Capital employed Revenue Capital employed
If a business is experiencing a decline in ROCE, this could be due to
o A decline in the asset turnover ratio
o A fall in the profit margin
o A decline in both of the above
Liquidity ratios: measures the ability of the organization to meet its liabilities as they become
due (e.g. suppliers, interest on bank loans, overdrafts)
Current ratio: measures the adequacy if current assets to meet current liabilities (without
having to raise additional finance)
CURRENT ASSETS (AT PERIOD END)
CURRENT RATIO =
CURRENT LIABILITIES (AT PERIOD END)
Inventory holding period: measures the amount of time inventory is held before it is sold
 The shorter the period, the lower the holding costs of inventory and the faster inventory
can be converted into cash
AVERAGE INVENTORY ($)
INVENTORY HOLDING PERIOD (DAYS) = 365 x
COST OF SALES ($)
Receivables collection period: measures the amount of time receivables are held before they are
collected
 The shorter the period, the lower the financing costs of receivables and the faster
receivables can be converted into cash. Shorter period also indicate a lower risk of bad debt
AVERAGE RECEIVABLES ($)
RECEIVABLES COLLECTION PERIOD = 365 x
TOTAL CREDIT SALES ($)
Payables payment period: measures the amount of time payables are held before it is they are
paid
 Payables can be used as a form of interest-free financing. The longer the payables payment
period, the lower the financing cost. Longer periods also indicate more cash retention.
However, this needs to be balanced against the risk of losing access to payables financing
if suppliers are no longer willing to provide it
AVERAGE PAYABLES ($)
PAYABLE PAYMENT PERIOD = 365 x
TOTAL CREDIT PURCHASES ($)
Quick ratio (acid test ratio): measures immediately liquidity
  A low or declining ratio may indicate an inability to meet its liabilities as they come due.
This could result from insufficient cash flows to pay its suppliers on time or a cash
shortage due to investments in NCA
CURRENT ASSETS – INVENTORY (AT PERIOD END)
QUICK RATIO =
CURRENT LIABILITIES (AT PERIOD END)
Ways to increase liquidity ratio
- Using long-term finance (loans and equity) to finance acquisitions of non-current
assets. This is usually done to match the financing period with the useful life of the NCA
- Generating positive cash flows to repay short-term liabilities on time
Gearing (or “leverage”): measures the portion of a company’s finance provided by debt
- The advantage of debt is that it is a relatively cheap source of financing
o Providers of debt require a lower return than providers of equity finance because they
face less risk, as they receive preferential repayment in the event of default
o Interest in debt is also a tax-deductible expense, which further reduces the cost of
debt
- However, companied with too much debt (gearing) increase the risk of being unable to
repay the debt’s interest and principal
- Gearing ratios: measures the proportion of long-term borrowed funds (which pay a
fixed return) to equity capital (shareholders’ funds) and provide information about a
company’s financial risk due to debt burden
DEBT DEBT
x 100 (gives a gearing as a percentage) OR x 100
EQUITY EQUITY + DEBT
 Meaning: A gearing ratio in isolation means very little. It is only useful if the gearing of
the organisation is compared with industry averages or with other companies in the
same business area to determine whether or not the gearing is too high.
- In industries with stable profits, companies can sustain higher gearing levels. High
gearing ratios increase risk in companies where profits fluctuate because a fall in profits
may mean the company cannot repay interest on its loans.
- An increase in gearing over time may reflect changes in the level of debt deemed
acceptable to the finance director. Alternatively, it may indicate that insufficient cash
flows cause the company to borrow money to finance short-term operations.
Interest cover: shows how much the return on debt (interest) is covered by profit (before tax
because interest is an allowable expense for income tax purposes). Lenders use this measure to
determine the vulnerability (sensitivity) of interest payments to a fall in profit
PROFIT BEFORE INTEREST AND TAX
INTEREST COVER =
INTEREST

APPROACH TO FINANCIAL PERFORMANCE EVALUATION EXAM QUESTIONS

- Review the “big picture” – look at revenue growth, profit growth and any other major
trends visible in the data
- Calculate a limited number of ratios that you think are necessary to investigate further
any trends identified in the analysis (e.g. if revenues have grown, but profits have not
changed, it may be worth calculating gross profit margins to determine if this is the cause
of the sluggish profits)
- If capital is given, calculate the ROCE, as this can indicate how well the organization
provides a return on the capital invested
- Review the information given in the scenario and look for clues which might explain the
trends. Information such as “the company operates in a competitive environment” might
explain falling gross profit margins.
 Having planned in this way, start to write your answer. Comment on each trend identified.
Comment means
- State what happened (e.g. profit increased by 20% between quarter 1 and quarter 2)
- State why this happened using any relevant information provided in the scenario to help
identify why (e.g. revenue increased by 10%, and many of the company’s costs are fixed,
which has led to a 20% rise in profits)
- Link this to other related items. For example, investment in new machinery that increases
capacity or capability may cause a significant increase in depreciation. On the other hand,
retaining and maintaining legacy (old) machinery may cause increasing repair spending.
- Express an opinion (e.g. an increase in profits of 20% is impressive given that the
company is operating in a competitive environment)
15.3. Non-financial Performance Indicators (NFPIs)
Financial performance indicators (FPIs)
Inherent weaknesses
- FPIs may lead to excessive focus on cost reduction. Short-term cost reductions may be
achieved at the expense of long-term performance due to the effect on staff morale,
quality and other factors
- FPIs ignore the drivers of business success. The things which drive business success are:
quality, delivery, customer satisfaction, after-sales service
- FPIs can be affected by using different accounting policies and “window dressing” to
make the performance look better
Possible solutions are to use:
o Profit growth over several years
o Encouraging managers to consider the factors that drive long-term success using non-
financial performance measures
Short-termism (or myopia) may exist for the following reasons:
- Receiving a bonus now seems much more attractive than earning it in the future.
- If managers expect to be promoted, or there is high management turnover, they may view
that future financial performance is irrelevant to them, as they will be working elsewhere
by then.
- Shareholders may take a short-term view of performance and will be disappointed if the
targets of the current period are not met. This is particularly relevant to listed companies
that fear failure to meet the quarterly earnings expectations of stock market investors.
  Short-termism can be a particular problem in the public sector because governments
typically set budgets annually with no longer-term plans being set.
Short-term financial gain vs. Long-term sustainability
Key performance indicators
- Many companies identify critical success factors (CSFs) at the strategic level
- Organizations should only identify a few CSFs, usually from their mission statement,
objectives and strategy
- Key performance indicators (KPIs) measure how well an organization meets its critical
success factors
- KPIs should be: specific, measurable, relevant
Operational NFPIs
Attribute NFPI
(a) Product quality • Percentage of items rejected by quality control
• Number of items returned by customers
(b) Product delivery • Percentage of customer orders delivered on time
• Waiting time from order to delivery
(c) Customer satisfaction • Number of customers returning
• Number of complaints
(d) After-sales service • Waiting time
• Number of complaints
• Customer surveys to measure their satisfaction
Ways to improve performance indicated by NFPIs
- Quality indicators: Quality control & Quality assurance
- Customer service
o Training to ensure staff understanding the importance of customer service
o Incentives to staff to reward improvements
Target setting in qualitative areas
CHAPTER 16: FURTHER ASPECTS OF PERFORMANCE
ANALYSIS
16.1. The balanced scorecard (sustained financial success & long-term shareholder
value)
- Objective: provide top management with an integrated set of performance measures
1. Customer perspective – how do our customers see us?
2. Internal business process perspective – at what must we excel?
3. Learning (or innovation) and growth perspective – how can we continue to grow and
change in the modern dynamic business environment?
4. Financial perspective – how do we look to shareholders?
- For each perspective, management needs to identify
o Objectives – what are the main objectives?
o Measures – how can the performance be measured against the objectives?
o Targets – what targets should be set for each measure?
o Initiatives – what actions could be taken to improve performance?
- Lagging (downstream) indicators show the effect of decisions long after they are made
(financial measures)
- Leading (upstream) indicators drive future financial performance (customers, internal
business processes, learning and growth)
Example
For low-cost airlines to stay competitive, management must develop performance measures which
support the carriers' strategy and focus on critical aspects of performance.
Objective Measure
Business process perspective
Punctuality % of flights on time
Effectiveness of direct selling Enquiry/booking conversion rate
Innovation and growth Time taken to build traffic to breakeven load factor for new
Route network development routes
Number of routes withdrawn
Development of individuals Expenditure on training
Internal promotion rates
Customer perspective
Customer satisfaction Customer ratings (service/VMF)
Customer complaints/compensation payments
Customer loyalty Repeat business
Switching to other airlines
Financial perspective
Profitability Return on capital employed
 Financial stability Gearing
Utilization Load factors
Low costs Cabin crew cost per seat per km
Advantages
- Helps to clarify how sustained, good financial performance can be achieved: what do our
customers expect? How do we deliver that well? How do we remain competitive?
- How do different aspects of the business result in good financial performance? For
example, if a new website is developed (innovation and learning), this could streamline
the ordering and despatch process as these can be integrated and automated (internal
business process perspective) and customers should be delighted because they can
browse products, order easily and reliably receive the goods quickly.
- Conversely, it can highlight how poor performance in any area can damage long-term
prosperity
- All important aspects of a company’s existence are measured and monitored. Without the
balanced scorecard, there is a danger that only financial results are studied. Without
measurement the company is working blind.
- Targets are set for current and future performance across a wide range of important
activities and measures.
- It helps to balance long-term and short-term objectives. Short-term objectives often take
precedence over long term objectives such as when a company reduces research and
development expenditure or reduces the number of customer-facing staff to achieve this
year’s budgeted profit. However, those cost cuts may have adverse longer-term effects,
which are picked up on customer perspective and innovation and learning measures.
Criticisms
- Potential information overload. There are four perspectives and even just five measures
for each will result in 20 overall. Some sort of prioritisation is certainly needed to stop
managers concentrating on easy-to-achieve targets at the expense of vital objectives.
- Picking or inventing measures can be difficult and perhaps arbitrary. As explained above,
staff morale and customer satisfaction are important but will they be measured
accurately?
- Difficulty and cost in obtaining the information needed.
- Conflict. For example, flexibility in supplying a customer with a product might adversely
affect the quality of the product if it is made in a rush.
 - Too little attention to external factors such as competitor activity. It is very
much our innovation, our processes, our customers.

16.2. Service industries

Characteristics of service industries
- Simultaneity (inseparability): serves are consumed as they are produced
- Heterogeneity (variability): each service provided could be unique because people are
involved, and the quality of service cannot be standardized
- Intangibility: the service may have no physical aspects. As a consequence, the service
provider may find it challenging to identify the service aspects customers value
- Perishability: services cannot be stored. A service must be provided when the customer
wants; it cannot be prepared in advance
Fitzgerald and Moon’s building block model

- Dimensions: aspects of performance

o Results: financial performance and competitiveness
o Determinants: quality, resource utilization, flexibility and innovation
- Standards (3 principles)
o Ownership: managers should take ownership of (believe in) the targets
o Achievability: targets should be challenging but achievable; otherwise, managers
will dismiss them rather than be motivated to achieve them
o Equity: the organization should maintain a realistic level of difficulty for its
standards across all business areas and be fair and unbiased in its performance
assessment
 - Reward schemes (3 principles)
o Clarity: employees must understand the performance measurement scheme
o Motivation: bonuses should motivate staff to achieve the targets
o Controllability: managers’ performance evaluations should only measure factors
they control
Example
SmartC is a package delivery company located in Maxland, a developing country. Since its formation
50 years ago, it has become one of the country's largest and most successful shipping companies. Its
mission is “to exceed customers’ expectations in the transfer of packages by offering the highest
quality services at competitive prices”. SmartC offers a range of delivery services, such as:
 Standard overnight delivery;
 A premium add-on of guaranteed 10:30 am delivery;
 A cheaper, three-day service for less time-critical deliveries
SmartC has recently launched an app that allows customers to set pickup times and locations on their
smartphones, which has received positive reviews in the technology press.
SmartC has identified the following critical success factors:
 Deliver sustainable profits to shareholders;
 Leave customers highly satisfied at every interaction with SmartC;
 Provide a range of services which meet our clients’ evolving needs;
 Lead the industry with constant innovation.
Managers at SmartC have a dynamic compensation package which includes share options, goalbased
incentives, commissions, and non-monetary public recognition. SmartC also allows for flexible work
schedules and is piloting an on-site childcare programme at one of its locations.
SmartC receives positive coverage in the press about its work environment and is considered an
attractive employer, with motivated employees and a good reputation among job seekers.
However, SmartC’s profits have dropped in recent years due to increasing competition from global
transport companies recently entering the Maxland market.
Applying the building block model:
Dimensions
Results: As a listed company, management will be very interested in measuring financial success – is it
delivering sufficient profits and returns for its shareholders?
Competitiveness is also critical to measure as new competitors are entering the market in Max land – is
SmartC maintaining or losing market share?
Determinants: SmartC’s managers and staff need to focus on the dimensions of performance that will
determine positive financial and competitive results. For example, on-time deliveries will lead to
customer loyalty. This falls under quality of service. The company’s varied service range should meet
the needs of different customer segments; this is an example of service flexibility. Flexibility and
quality of service should, in turn, drive positive financial results, for example, higher sales revenue.

Innovation is also essential to SmartC as it invests in new technology and improves processes with its
smartphone app. Resource utilisation is critical to its financial success as efficient use of delivery
vehicles, staff and financial resources will reduce costs and improve profitability. In other words,
innovation and resource utilisation drive financial success (higher profits) and competitiveness
(maintaining market share).

Setting standards for dimensions

 Financial performance: Growth in sales, net profit margin and return on investment (ROI) are potential
targets for regional managers. For example, fixed target could be set, such as 8% annual growth in
sales or a target ROI of 14%. Or, SmartC could use a league table approach by ranking the regions
according to these standards and then rewarding managers accordingly.
Competitiveness: With new players in the market, SmartC needs to measure this area of external
performance. It can set absolute market share as a standard for measuring competitiveness by dividing
SmartC’s revenue by the total revenue of the industry in Maxland. A target for regional managers
could be to maintain market share as competitive rivalry is increasing in the industry
Quality: As a service organization, SmartC must deliver quality service to retain its customer base. It
can set targets for courier agents, such as 98% on-time delivery or call center representatives to take an
order in 3 minutes on average. It will be essential to ensure that these targets are fair and achievable to
motivate employees.
Flexibility of service and innovation: Flexibility of service can be measured with targets such as 90%
of orders scheduled to customers’ requests. Innovation can be measured by the % of customers using
the smartphone app.
Resource utilization: SmartC can measure resource utilization using efficiency standards such as
average delivery time or number of deliveries per day. However, equity should be considered here, as
urban regions could outperform rural regions as urban customers will be clustered closer together.
Rewards: SmartC appears to have an effective reward system. The compensation package covers a
range of financial and non-financial rewards and benefits, which contribute to the motivation of
employees by meeting their different needs. For example, new parents will be motivated by the
childcare facilities; other staff may be motivated by the flexible workplace arrangements. It also
appears that rewards are performance-based (e.g. “goal-based incentives”), leading to increased
motivation. SmartC must ensure that rewards are controllable and clear, for example, by providing
targets that are well-defined and then agreed upon in appraisal meetings
16.3. Non-profit sector
The non-profit sector includes
- Public sector bodies such as schools and hospitals
- Not-for-profit (NFP) organizations (charities) and non-governmental organizations
(NGOs)
 Distinguished from profit maximizing organizations
• Do not have external shareholders providing risk capital
• Do not distribute dividends, so any profit (surplus) generated is retained by the
business as a further source of capital
• Objectives include some social, cultural, welfare or environment dimension
Value for money (VFM) framework: 3Es
1. Economy: minimizing inputs in terms of lowest cost for the quality required (i.e. the
lowest cost option may not necessarily be chosen if it does not provide sufficient quality)
2. Efficiency: maximizing the output/input ratio
3. Effectiveness: achievement of objectives
Example: NFP objectives
In recent decades, the public sector has considerably increased management accounting adoption (e.g.
 in hospitals and schools)
Many governments specify objectives for public services, for example:
Hospital – to improve the standard of patient care
Schools – to improve the quality of education
Governments have also stressed the efficient use of resources in these areas
Required: Comment on the above objectives and assess how management accounting can
contribute towards their achievement
The objectives quoted in the question are too general to provide a mechanism for measuring whether
the school or hospital has attained those objectives.
Despite widely acknowledged difficulties measuring the efficiency and effectiveness of not-for-profit
(NFP) organizations, management accountants must help managers involved in decisions regarding the
organization’s resources. This is especially so in the case of NFP organizations, where a significant
proportion of the cost base is fixed.
 Economy can be defined as: "The terms and conditions under which the authority acquires human
and material resources. An economical operation acquires resources of the appropriate quality and
provides a service to the appropriate standard at the lowest cost."
 Effectiveness is "The extent to which a programme achieves its established goals or other
intended effects."
 Efficiency is: "The relationship between goods or services produced and resources used to
produce them. An efficient operation produces the maximum output for any given resource input
or minimum input for any given quantity and quality of services provided."
From the above definitions, it can be seen that efficiency is the optimum of economy and effectiveness
(i.e. the measure of output over input).
The above "3Es" explains what governments mean by "the efficient use of resources in these areas".
The introduction of management accounting techniques within hospitals and schools has led managers
to focus more on achieving economy, efficiency and effectiveness.
The principal problem, typical of schools and hospitals, is measuring such organisations' output (i.e.
effectiveness).
In acknowledging that non-financial objectives can be more subjective than financial objectives when
deciding whether they have been achieved, management accountants need to ensure the definition of
organisational objectives in a manner which facilitates the measurement of the extent to which "patient
care" and "quality of education" have been achieved.
Measurable objectives having been established, the management accountant should develop
performance indicators to measure effectiveness (i.e., the extent to which the prescribed goals have
been met).
The management accountant must ensure that the control systems capture the information used to
assess the organisation's effectiveness and that any deficiencies are remedied.
Non-financial performance indicators (NFPIs)
Example
Proposed indicator Why a useful measure
1. Quality of education in a school Exam results are a measure of how much the pupils have
Exam results - % of pupils passing final learned. Pass rates reflect how well the students have been
exams taught.
% of pupils that achieve entry to One objective of schools is to enable talented students to
University or higher education achieve their potential and gain entry to a good university
2. Effectiveness of charity in reducing the
effects of a disease
 Fall in the number of cases of a disease
reported each period Shows a fall in the disease, which may reflect the
Number of people inoculated against a charity’s work
disease Reflects the work performed by the charity (although this
may not measure very well how effective the results were)
3. Quality of clinical care in a hospital
% of patients that are cured and not Shows % of cases with a positive outcome, reflecting the
readmitted within three months level of clinical care given.
Waiting time for operation (time from Long waiting times may be caused by poor clinical care in
referral by doctor until procedure hospitals, delaying additional operations.
performed)
4. Effectiveness of local police force Reflect the ability of police to collect sufficient evidence
% of arrested criminals convicted to ensure criminals are convicted
Setting target
Assessing performance
Example
Ayersome Leisure (AL) is a sports centre owned and managed by the council of Bigton. Its mission is
"To promote healthy living in Bigton". The council has become increasingly concerned by the growing
deficit generated by the centre as the council has to subsidise all such deficits.
The financial report of the centre for the last two financial years (most recent and prior) and the budget
for the most recent year are as follows:
Prior Most recent Budget
$000 $000 $000
Revenue 700 606 792
Less costs:
Depreciation 25 25 25
Salaries 450 500 550
Maintenance 150 200 200
Other costs 124 75 125
(49) (194) (108)
The centre offers four sporting activities: Squash, Swimming, Gym and Badminton. The following
information is available in respect of these for the most recent financial year:
Squash Swimming Gym Badminton
Hours open each day: 12 10 12 6
% utilisation
Daytime 50 70 15 50
Evening 80 70 50 50
Revenue ($000) 101 203 252 50
Annual cost saving ($000)
If activity is discontinued: 21 120 51 60
AL offers free access to all facilities to local schools to encourage sports development and to those
over 60 years old to promote healthy lifestyles. Free-access users comprise 30% of all users. It is
estimated that 60% of these users would continue using the facilities if they had to pay the standard
charges. The remaining 40% would not use the facilities if free access were withdrawn.
Except for the avoidable costs identified (i.e. the annual cost savings if an activity is discontinued), all
costs are general fixed overheads.
There has been a decline in evening users of both the gym and the swimming pool because a private
health club opened during the year in Bigton. A former visitor to the club commented that he preferred
the health club because even though it was much more expensive than AL, it attracted a more exclusive
clientele.
a. Evaluate the financial & non-financial performance of the sports centre for the most recent
year
The deficit for the most recent financial year is $194,000. This is almost four times that of the prior
year and 80% higher than the budgeted deficit. Understandably, the council is concerned about this.
The main reason for failure to meet the budget is the decline in revenue, most likely due to opening of
a new health club in Bigton, which has attracted some users away from a public sports centre.
There is little that AL’s management can do about this, as it would not be appropriate for a publicly-
funded leisure centre to offer the same luxurious levels of service as a private health club. However,
the existence of the competition and the expected decrease in revenue must be planned for in the future
and costs reduced.
Salaries have increased by 11% compared to the prior year, although this is only half the budgeted
increase. This is due to either increased staff numbers or increased salaries or both. Given the revenue
decline, management should not have raised the staffing level.
Accessibility of the sports centre is good, with squash and gym being available 12 hours per day and
swimming 10 hours per day. Badminton is only available for six hours daily, which may reflect a lack
of demand.
The utilisation of all activities is over 50% except for the gym, which has only 15% utilisation during
the day, perhaps due to gym users being at work. Squash is particularly in demand, with 80%
utilisation in the evenings.
The high utilisation rates mean that the centre provides services valued by the community.
The provision of free facilities to the over 60s and schools may appear to be bad from a financial point
of view, but AL's objective is to promote healthy living, not to make a profit. Of the 30% of users who
enjoy free access, 40% would not use the facilities if they had to pay, so the sports centre satisfies a
social need by encouraging people to exercise.
Overall, the financial performance is poor, and the sports centre needs to find ways to reduce the deficit
in future years. However, the sports centre provides the local community with a good and valued
service.
b. Suggest ways the centre's financial performance could be improved
- Accept the revenue fall
- Improve financial performance = Cost reductions
o Discontinued unpopular activity (revenue < cost => save $10,000)
o Reducing staff to prior year level & further during times of low utilization
o Reduce availability of popular activites during less busy time (open 1 hour later and close 1
hour earlier to save cost without causing too much inconvenience)
o If no more free access, 60% would continue to use => increase in revenue (30% x $606,000
x 60%) but go against AL’s stated mission => Perhaps free access to over-60s
As noted in part (a), revenue fell considerably due to the opening of a private health club. The private
club provides an exclusive service to its clients, while a publicly-owned sports centre has an objective
of inclusivity. There is little that AL can do to win back the clients who prefer the exclusivity of a
 private club, so the revenue fall must be accepted. Therefore, improving financial performance requires
AL to focus on cost reductions.
Badminton is not a particularly popular activity. Revenue from badminton was $50,000. If Badminton
were discontinued, costs of $60,000 would be avoided. Therefore, ceasing badminton would save
$10,000 a year.
Management may consider reducing staff costs. Reducing staff costs to prior year levels would save
$50,000. Additional savings might be possible if staff levels are reduced during times of low utilisation
(e.g. in the gym during the day when usage is only 15%).
While squash and swimming are available for 12 hours per day, it may be possible to reduce this
availability during less busy times. Opening one hour later and closing one hour earlier could save
costs without causing too much inconvenience to users.
Finally, it is noted that 30% of users enjoy free access. If this were to be withdrawn, 60% of these
would continue to use the facilities. This means revenue would increase by approximately $109,000
(30% × 606,000 × 60%). However, withdrawing free access may go against AL's stated mission. As a
compromise, perhaps free access to over-60s could be "means-tested" (i.e. individuals over 60 on low
incomes would continue to enjoy free entry, but those on higher incomes would have to pay).
Other approaches:
- ZBB
- Benchmarking: compares the performance of a public sector organization to that of a
“best-in-class” organization
- League table – used in health, policing and education
16.4. External considerations
Stakeholders: any person or group affected by an organization
- Traditionally, performance management focused only on the owners’ interest. Ignoring
stakeholder objectives may result in adverse implications for an organization
- Staff surveys are common method used to assess staff satisfaction
Group Objectives
Employees Satisfactory remuneration
Good working conditions
Customers Good-quality products
Suppliers Long-term relationships
Pay within agreed terms
General public Employment opportunities
Economic effect on the region
Environmental impact
Government Compliance with law (e.g. environment)

Example
The government of Northland privatised the Northland Railway Company in 20X6. The company was
split into smaller companies, each operating the trains on a specific route. These companies were then
sold to the private sector.
One of the private companies formed was the Great Suburban Railway Company, which provides
passenger train services on a busy commuter route between the capital city of Bigton and Smallton, a
distance of 100 km.
Financial and other information relating to the Great Suburban Railway for three financial years are
presented below.
20X7 20X8 20X9
Revenue ($000) 30,000 32,000 35,000
Profit ($000) (1,000) 2,000 5,000
Number of passenger journeys (000) 2,000 1,900 1,900
Number of employees 500 450 400
% of trains arriving on time 70% 72% 75%
Other information
The Great Suburban Railway is the only company licensed to operate a rail route between Bigton and
Smallton.
The aims of privatising the trains were to stop the subsidy the government had previously paid to the
train company and to increase the punctuality of services.
Since privatisation, passengers have complained that the number of carriages on each train has been
reduced, leading to a shortage of seats during peak times.
Required: Discuss the performance of the Great Suburban Railway from the perspective of
a. A shareholder
Shareholders will be pleased with the performance since privatisation. Revenues have increased by
16.67% from 20X7 to 20X9, which is good for a business such as railways where demand is likely to
be limited. The increase appears due to higher ticket prices, as the number of passenger journeys
(volume) fell during the period.
While the company recorded a loss in 20X7, the first year after privatisation, it made a good profit in
20X8 and 20X9. Profits have risen by more than revenue in absolute terms. This shows that the
company has reduced costs at the same time that revenues have increased. Net profit margin rose from
6.25% in 20X8 to 14.2% in 20X9.
The company has performed well from the perspective of shareholders.
b. The government
Generally, The government will be pleased that it no longer has to subsidise the railway and that the
company appears to survive in the private sector.
Another objective of privatisation was to increase the punctuality of trains. The Great Suburban
Railway has improved punctuality, measured as the percentage of trains arriving on time, from 70% to
75% between 20X7 and 20X9, so some progress has been made. However, 25% of trains are still
late, and the government (and passengers) will not be pleased.
c. The population of Smallton
The main objective for the people of Smallton likely is to have a reliable train service to the capital
which charges reasonable prices.
Punctuality has already been discussed, and passengers would likely be happy with the increase in the
percentage of trains arriving on time. However, they would hope for further improvements in this area.
One area that customers are likely to be unhappy about is the apparent increase in ticket prices.
Dividing total revenue by number of passenger journeys, the average ticket per journey has risen from
$15 in 20X7 to $18.42 in 20X9, an increase of 22%. This is a significant increase and is not likely to be
popular unless accompanied by better service in some way.
 Customers also complain about the reduced number of carriages, leaving people without seats during
peak times. So, it does not appear that passengers are experiencing better service.
The number of passengers has fallen by 5% between 20X7 and 20X9. This is likely to be due to the
increase in prices. People may find alternative ways to travel to the capital (such as by bus or car) or
reduce their journeys.
Overall, the people of Smallton are not likely to be happy with the performance of the privatised
company.
Market conditions and competitors
Sustainability: meeting the needs of the present without compromising the ability of future
generations to meet their own needs
CHAPTER 17: DIVISIONAL PERFORMANCE EVALUATION
17.1. Decentralization: delegation of authority to make decisions
- Revenue centers: decisions about revenue generation (usually selling costs)
- Cost centers: costs
- Profit centers: costs and revenue
- Investment centers: cost, revenues and asset investment decisions
Benefit
- Senior management can concentrate on strategy
- Faster decision-making: divisional managers are “on the spot” and can react quickly to
changes
- Better decision-making: specialist managers will likely understand their part of the
business better than senior management
- Motivation: divisional managers are given responsibility and status and may increase
effort
- Training and career progression: divisional managers acquire skills and experience which
may prepare them for senior management (e.g. ‘rotated’ between divisions)
- Tax advantages: locating divisions in certain areas which enjoy tax incentives or
government grants
Problems
- Lack of goal congruence: the risk that divisional managers will make decisions
inconsistent with overall organizational objectives
- Increased information requirements: reporting systems must be introduced
- Lost economies of scale: costs may rise through duplication of common activities. A
central purchasing department may achieve better prices and lower overall overhead than
divisional purchasing departments
- Loss of central control: conflicts may occur if top management disagrees with the
decisions of divisional managers
Conditions for successful decentralization
- Business has several separate activities
- Divisions should be independent from each other
- Central policies to integrate and control (e.g. major capital expenditure, strategic
decisions and transfer prices)
 - Carefully designed performance evaluation systems to reduce risk of dysfunctional
decisions
17.2. Divisional performance evaluation
Measurement characteristics
- A significant risk of decentralization: managers make decisions that are not in the best
interests of the overall company (dysfunctional decisions)
- A good performance measurement system
o Goal congruence: encourage decisions consistent with company objectives
o Timeliness: reporting fast enough to allow any required corrective action
o Controllability: evaluation only on performance under control
Possible measures
- Ratio analysis
Profitability Liquidity Other measures
Net profit margin Current ratio Contribution per key factor/
limited resource
Gross profit margin Quick ratio Sales per employee
Contribution margin Receivables collection period Industry-specific cost-related
Expenses as a Payables payment period ratios: transport cost per km;
percentage of sales Inventory holding period overheads per chargeable hour
- Non-financial measures
• Staff turnover • %Returns
• New customers gained • %Rejects/reworks (number of complaints
• Proportion of repeat booking received)
• Orders received • On-time deliveries
• Set-up times (customer waiting time) • Client contact hours
• New products developed • Training time per employee
- Measures by division
Division type Possible measure
Revenue Financial sales variances (volume, price, mix)
center selling cost ratio
Non-financial sales volume per employee
customer satisfaction rating
customer retention
Cost center Financial cost variances
 costs per unit produced
Non-financial labor turnover
Profit center Financial controllable profit (if assessing manager)
traceable profit (if assessing division)
sales variances; profit margin; contribution margins
Non-financial customer returns
Investment Financial return on investment
center residual income
liquidity ratio: current ratio; receivables days
Non-financial number of new products developed
Controllable and traceable profit
- Controllable profit used to assess the manager’s performance
- Traceable profit used to assess the division’s performance
$ $
External sales x
Internal sales x
x
Variable costs x
Controllable by manager
Fixed costs x
(x)
Controllable divisional profit x
Divisional costs outside manager’s control (x)
Traceable divisional profit x
Allocated head-office costs (x)
Divisional net profit x
 ROI & RI là 2 chỉ tiêu cơ bản để đánh giá hiệu quả hoạt động của các bộ
phận (division) được tổ chức theo hình thức các trung tâm đầu tư (investment
center)
17.3. Return on investment (ROI): a return on capital employed which compares
income with the operational assets used to generate that income
 Profit is BEFORE INTEREST AND TAX/AFTER DEPRECIATION because
interest is affected by financing decisions, and tax is an appropriation
For manager For division
 Controllable profit Traceable profit
ROI = x 100 ROI = x 100
Capital employed Capital employed
 Decision rule – divisional performance is favorable if ROI is greater than the cost
of capital
Components of capital

- ROI is the divisional version of company ROCE (advise shareholders to buy or sell the
company’s shares)
- It is a measure of divisional performance, NOT an investment appraisal method

- If divisional managers choose projects with high ROI, the division’s ROI should be high.
The head office will favorably assess the manager
- But an ROI hurdle should not be the sole measure of a division’s purpose, as it may lead
to dysfunctional decisions
Advantages
- As a relative measure, it is easy to compare divisions.
- Similar to ROCE used externally by analysts.
- Focuses attention on scarce capital resources.
- Encourages reduction in non-essential investment by: selling off unused non-current
assets; and minimising the investment in working capital.
- Easily understood percentages (especially by non-financial managers)
- Can be further analysed (i.e. between profit margin and asset turnover)
Disadvantages
- Risk of dysfunctional decision-making
- The definition of capital employed is subjective
- If net book value is used, ROI will increase over time because of depreciation.
- Risk of window-dressing; boosting reported ROI by: under-investing; and cutting
discretionary costs (especially if ROI is linked to bonus systems).
17.4. Residual income: pre-tax profit less imputed interest charge for capital invested
For manager For division
Controllable profit x Traceable profit x
Imputed interest charge (x) Imputed interest charge (x)
Residual income x Residual income x
- Imputed interest: notional interest charge on the division by the head office
IMPUTED INTEREST = CAPITAL EMPLOYED x INTEREST RATE
 Decision rule – accept a project/investment if RI is positive
Advantages
- RI overcomes some of the problems associated with ROI (dysfunctional behavior and
holding on to old assets)
- It can be linked to NPV, which, theoretically, is the best way to make investment
decisions. The PV of an investment's residual income equals the investment's NPV. In the
long run, companies that maximise RI will also maximise NPV and, in turn, shareholder
wealth
- A risk-adjusted cost of capital can reflect different risk positions of different divisions
Disadvantages
- Definition of capital employed
- Effect of depreciation
- Window dressing
- It is challenging to compare divisions of different sizes. The manager of the larger
division will generally show a higher residual income because of the size of the division
rather than superior managerial performance
- Less easily understood than a percentage
CHAPTER 18: TRANSFER PRICING
18.1. Transfer pricing: the price at which one division transfers goods or services to another
division within a company or from one subsidiary to another within a group
When needed
- An organization has been decentralized into divisions
- Inter-division trading of goods or services occurs
Objectives
- Goal congruence: encourage divisions with each other to trade in a way that maximize
profits for the company
- Division autonomy: divisional managers should be free to make their own decisions and
autonomy should improve their motivation
- Divisional performance evaluation: should be ‘fair’ and allow an objective assessment
 If there is a conflict between two objectives of a transfer pricing system, goal congruence
must take priority
18.2. Opportunity cost approach
Supplying division pespective: accept a MINIMUM transfer price
= MARGINAL (VARIABLE COST) + OPPORTUNITY COST
- Scenario 1: Opportunity cost is zero (internal transfers do not reduce contribution from
external sales)
No external market or and No production constraints
External market but spare capacity
- Scenario 2: Opportunity cost arises (an internal sale sacrifices an external sale)
An external market exists, and
The supplying division operates at full capacity
Buying division perspective: MAXIMUM transfer price acceptable will be the lower of
- The external market price (if an external market exists); or
- The net revenue of the buying division
Economic transfer price rule
Minimum (per selling division) transfer price ≥ Marginal cost of selling division
and
Maximum (per buying division) transfer price ≤ The lower of
• External market price (if an external market exists); and
 • Net marginal revenue of buying division
18.3. Practical approach
Market price method
- If buying and selling divisions can buy/sell externally at market price
- Need to be adjusted downwards if internal sales incur lower costs than external sales
(e.g. due to lower delivery costs)
Advantages Disadvantages
Optimal for goal congruence if the selling division Only possible if a perfectly competitive external
is at full capacity market exists
Encourage efficiency: the supplying division must Market prices may fluctuate
compete with external competition
Full cost plus
- The supplying division charges full absorption cost pluss a mark-up
- Standard costs should be used rather than actual costs to avoid selling divisions
transferring inefficiencies to buying divisions
Easy to calculate if standard costing system exists The fixed costs of them selling division become
Covers all costs of the selling division the variable costs of the buying division – may
May approximate to market price lead to dysfunctional decisions
If the selling division has spare capacity, it may
lead to dysfunctional decisions
The markup is arbitrary
Variable cost plus is similar to full cost plus
Marginal cost = Variable cost + Any incremental fixed costs (e.g. stepped costs)
Optimal for goal congruence when: selling division It may be dificult to calculate (variable cost is
has spare capacity; or no external market exists often used as an approximation)
 Any transfer price other than the variable cost of the transferring division has the risk of
dysfunctional decision-making unless an upper limit equal to the net (marginal) revenue
in the receiving division is also imposed
18.4. Dual pricing: is sometimes used in situations where no transfer price would be
acceptable to both the buying and selling division
- A higher price is used when calculating the revenue of the selling division for goods
supplied to the buying division
- A lower price is used when calculating the costs in the buying division for the goods
supplied to it by the selling division
- The head office absorbs the difference between the two as a head office overhead
KIẾN THỨC CƠ BẢN
Transfer price: áp dụng cho các giao dịch mua bán nội bộ giữa các bộ phận trong công ty/tổ
chức
3 vấn đề khi xây dựng “Transfer price”
- Divisional autonomy: các bộ phận ra quyết định để tối ưu lợi ích chính họ thay vì công
ty
- Corporate profit maximization: các bộ phận tranh cãi về mức sản lượng đầu ra phù hợp
nên lợi nhuận của toàn công ty sẽ không được tối ưu
- Divisional performance: mức giá chuyển nhượng ảnh hưởng đến hành vi và quyết định
của các bộ phận
 Mức giá chuyển nhượng lý tưởng phải bảo đảm
- Bộ phận bán kiếm lợi nhuận bù đắp cho công sức của họ. Bộ phận mua chỉ phát sinh chi
phí tương ứng lợi ích mà họ nhận được
- Khuyến khích bộ phận thực hiện chuyển nhượng và tối đa hoá lợi nhuận tổng thể công ty
- Xây dựng ở mức “hợp lí” đảm bảo kết quả hoạt động các bộ phận được đánh giá “hợp lí”
Nguyên tắc
Mức giá tối thiểu (Minimum price) = Chi phí cận biên (Marginal cost) của bộ phận bán +
Chi phí cơ hội bộ phận bán mất khi chuyển nhượng hàng hoá nội bộ
Mức giá tối đa (Maximum price) = Giá thị trường (Market price) thấp nhất mà bộ phận
mua có thể mua từ nhà cung cấp khác – Chi phí nội bộ tiết kiệm được trong đóng gói, vận
chuyển
VD: Công ty có 2 bộ phận A và B
- A sản xuất sản phẩm với chi phí cận biên là $100/unit và A có thể bán sản phẩm cho
khách hàng bên ngoài, thu về lợi nhuận gộp (contribution) là $20
- B có thể mua sản phẩm này từ nhà cung cấp khác với giá $160/unit
 Mininum price = 100 + 20 = $120; Maximum price = $160
 TH bộ phận bán có công suất dư thừa, có thể vừa bán cho nội bộ, vừa sản xuất bán cho
bên ngoài thì KHÔNG PHÁT SINH CHI PHÍ CƠ HỘI khi bán nội bộ
Cách xây dựng chính sách Giá chuyển nhượng tối ưu (Optimal transfer price)
- Mức giá chuyển nhượng lý tưởng nên phản ánh chi phí cơ hội giao dịch của các bộ phận
- Khi tồn tại thị trường hoàn hảo (perfect market) & chi phí biến đổi, giá bán là không đổi:
Chi phí cơ hội của việc chuyển nhượng = Giá thị trường – Chi phí tiết kiệm được (nếu
có)
 - Khi không có thị trường cho sản phẩm nhưng chi phí biến đổi, giá bán là không đối: Giá
chuyển nhượng = Standard variable cost + chi phí cơ hội của việc chuyển nhượng
- Khi đơn giá bán và chi phí biến đổi thay đổi: mức giá chuyển nhượng lý tưởng chỉ có thể
xác định qua thương lượng và phân tích của các bộ phận
CƠ SỞ XÂY DỰNG
Xây dựng giá chuyển nhượng dựa trên giá thị trường “Market price”
- Áp dựng khi sản phẩm có thể được mua từ các nhà cung cấp bên ngoài khác
- Ưu điểm
o Lợi ích tốt nhất cho toàn bộ công ty: 2 bộ phận hưởng lợi vi chi phí quản lý, bán hàng
và vận chuyển rẻ hơn; bộ phận mua hưởng chất lượng tốt hơn, linh hoạt về thời gian
o Các bộ phận được tự do thương lượng, mặc cả => đảm bảo lợi ích tốt nhất
o Khi 1 cơ sở giá khác được áp dụng: luôn tranh cãi về sự hợp lí của giá chuyển
nhượng
- Nhược điểm
o Market price chỉ là tạm thời, ảnh hưởng bởi biến động thị trường
o Có thể khiến các nhà quản lý không muốn tận dụng công suất dư thừa (spare
capacity)
o Nhiều sản phẩm sẽ không có giá thị trường, phải sử dụng giá sản phẩm tương tự
o TH thị trường imperfect với sản phẩm (yêu cầu sản phẩm có giới hạn, cạnh tranh
không lành mạnh): bộ phận bán sẽ phải giảm giá bán khi cố gắng bán càng nhiều
càng tốt
Xây dựng giá chuyển nhượng dựa trên chi phí sản xuất
- Là cơ sở thường được sử dụng trong thực tế
- Giá chuyển nhượng có thể xác định theo tổng chi phí sản xuất hoặc chi phí biến đổi
- Full cost – nhược điểm: bên bán sẽ không có lợi nhuận nên không có động lực để thực
hiện giao dịch nội bộ và chi phí cố định cũng có nhiều cách phân bổ vào giá thành sản
phẩm => Thông thường DN sẽ cộng thêm 1 tỷ lệ lợi nhuận vào full cost
- Variable cost: bộ phận bán không đủ doanh thu để bù đắp chi phí cổ định
CASE STUDY
The Portable Garage Co (PGC) is a company specialising in the manufacture and sale of a range
of products for motorists. It is split into two divisions: the battery division (Division B) and the
adaptor division (Division A). Division B sells one product – portable battery chargers for
motorists which can be attached to a car’s own battery and used to start up the engine when the
car’s own battery fails. Division A sells adaptors which are used by customers to charge mobile
devices and laptops by attaching them to the car’s internal power source.
Recently, Division B has upgraded its portable battery so it can also be used to rapidly charge
mobile devices and laptops. The mobile device or laptop must be attached to the battery using a
special adaptor which is supplied to the customer with the battery. Division B currently buys the
adaptors from Division A, which also sells them externally to other companies.
The following data is available for both divisions:
Division B Division A
Selling price for each portable battery, Selling price per adaptor to Division B $13
including adaptor $180 Selling price per adaptor to external customers
$15
Costs per battery: Costs per adaptor:
Adaptor from Division A $13 Materials $3
Other materials from external suppliers Labour costs $4
$45 Labour costs $35
Annual fixed overheads $5,460,000 Annual fixed overheads $2,200,000
Annual production and sales of portable Current annual production capacity and sales of
batteries (units) 150,000 adaptors – both internal and external sales (units)
350,000
Maximum annual market demand for Maximum annual external demand for adaptors
portable batteries (units) 180,000 (units) 200,000
In addition to the materials and labour costs above, Division A incurs a variable cost of $1 per
adaptor for all adaptors it sells externally.
Currently, Head Office’s purchasing policy only allows Division B to purchase the adaptors from
Division A but Division A has refused to sell Division B any more than the current level of
adaptors it supplies to it.
The manager of Division B is unhappy. He has a special industry contact who he could buy the
adaptors from at exactly the same price charged by Division A if he were given the autonomy to
purchase from outside the group.
After discussions with both of the divisional managers and to ensure that the managers are not
demotivated, Head Office has now agreed to change the purchasing policy to allow Division B to
buy externally, provided that it optimises the profits of the group as a whole.
(a) Under the current transfer pricing system, prepare a profit statement showing the profit for
each of the divisions and for The Portable Garage Co (PGC) as a whole. Your sales and costs
figures should be split into external sales and inter-divisional transfers, where appropriate
Lập báo cáo lãi lỗ từng bộ phận và toàn công ty theo chính sách giá cũ
Items Division B ($’000) Division A ($’000) PGC Co ($’000)
Sales revenue:
External sales $180 x 150,000 = 27,000 $15 x 200,000 = 3,000 30,000
Internal transferred sales $13 x 150,000 = 1,950
Total revenue 27,000 4,950 30,000
Variable costs:
External material costs $45 x 150,000 = 6,750 $3 x 350,000 = 1,050 7,800
Internal transferred costs $13 x 150,000 = 1,950
Labor costs $35 x 150,000 = 5,250 $4 x 350,000 = 1,400 6,650
Other costs of external $1 x 200,000 = 200 200
sales
Total variable costs 13,950 2,650 14,650
Contribution 13,050 2,300 15,350
Less fixed costs 5,460 2,200 7,660
Profit 7,590 100 7,690
(b) Assuming that the new group purchasing policy will ensure the optimisation of group profits,
calculate and discuss the number of adaptors which Division B should buy from Division A and
the number of adaptors which Division A should sell to external customers.
Xác định sản lượng Division A nên bán nội bộ và bán ra bên ngoài theo chính sách giá mới
 Nhìn nhận các giao dịch từ góc độ tập đoàn chứ không phải từng bộ phận
- Giá bán thiết bị chuyển đổi của Division A ra bên ngoài là $15/unit
- Mỗi sản phẩm Division A bán ra bên ngoài sẽ mang lại cho tập đoàn lợi nhuận góp
(contribution) là: $15 - $3 - $4 - $1 = $7/unit
- Chi phí cần thiết tăng thêm cho tập đoàn khi Division B mua từ bên ngoài $13 – ($3 +
$4) = $6/unit
- Như vậy bù trừ đi thì mỗi sản phẩm Division A bán ra bên ngoài vẫn sẽ mang lại cho tập
đoàn $1 lợi nhuận. Do đó, từ góc độ tập đoàn, A nên bán tối đa ra bên ngoài. Còn lại thì
bán cho B với mức giá chuyển nhượng do 2 bên thoả thuận
 Sản lượng Division A bán ra bên ngoài: 200,000
 Sản lượng Division A cung cấp cho Division B: 150,000
  Sản lượng Division B phải mua từ nhà cung cấp bên ngoài: 30,000
Assume now that no external supplier exists for the adaptors which Division B uses.
(c) Calculate and discuss what the minimum transfer price per unit would be for any additional
adaptors supplied above the current level by Division A to Division B so that Division B can
meet its maximum annual demand for the new portable batteries.
Khi Division A bán cho Division B 180,000 sản phẩm nghĩa là Division A phải giảm thiểu doanh
số bán ra bên ngoài từ 200,000 xuống 170,000 sản phẩm. Do đó, đây là TH chuyển nhượng khi
không có công suất dư thừa nên giá chuyển nhượng tối thiểu trong TH này phải bảo gồm cả
chi phí cơ hội của việc chuyển nhượng. Cụ thể:
Mức giá tối thiểu (minimum price) = Chi phí cận biên (marginal cost) của bộ phận bán +
Chi phí cơ hội bộ phận bán bị mất khi chuyển nhượng hàng hoá nội bộ
Trong đó
- Chi phí cận biên của Division A khi chuyển nhượng nội bộ: $4 + $3 = $7
- Chi phí cơ hội Division A mất đi khi chuyển nhượng nội bộ: $7
- Giá chuyển nhượng tối thiểu: $14/unit
 September/December 2021
The country of Jayland has two airlines, Flag Co, its national airline, and Budget Co, a recent entrant
into the market
Flag Co was government owned until ten years ago but is now operated as a private company. Its
mission is ‘to be the airline of choice for long distance travelers’. It charges premium fares and
operates routes from Jayland’s capital city to the major airports serving the largest cities around the
world. Many of its flights have durations greater than 12 hours. The majority of its passengers are
travelling on business and are prepared to pay high prices, however the demand for business travel is
very sensitive to economic conditions. Its fleet of aircrafts is regarded as ‘ageing’ by industry analysis.
Budget Co was founded by a wealthy entrepreneur who invested their personal fortune in the
company’s equity. Its mission is ‘to be the lowest fare airline on any route we serve’. If offers flights to
desinations up to three hours travel from Jayland. Its fleet of aircraft are generally less than two years
old. Most of its passengers are holiday-makers and the demand for its flights appears to be relatively
insensitive to economic conditions
The following information is available for both companies:
Statement of profit or loss extract for year end Flag Co Budget Co
31 Dec 20X6 $m $m
Total revenue 11,333 6,654
Operating profit 1,239 404
Finance costs 250 50
Other non-operating costs 130 76
Profit before tax 859 278

Statements of financial position (summarized) as Flag Co Budget Co

at 31 Dec 20X6 $m $m
Non-current assets 11,972 3,177
Current assets (Note 1) 3,404 885
Total assets 15,376 4,062
Total equity 4,598 1,945
Non-current liabilities 5,078 1,001
Current liabilities 5,700 1,116
Total liabilities and shareholders equity 15,376 4,062
Note 1: Current assets include inventory of $2.1m and $1.1m respectively

Other information for year end 31 Dec 20X6 Flag Co Budget Co

Aviation fuel liters consumed (millions) 2.434 1.246
Available seat kilometers (millions) 21,423 14,953
Passenger seat kilometers (millions) 14,201 14,206
Operating gearing (contribution/profit before interest 950% 820%
and tax)
*Non-financial information => NFPIs
(a) Analyze the financial performance of the two airlines, including reasons for the
differences in the two businesses’ performance
Profitability
Flag Co Budget Co
ROCE 12.8% 13.7%
= PBIT/Capital employed (859+130+250)/(4,598+5,078) (278+76+50)/(1,945+1,001)
= PBT + Other non-operating costs
+ Finance cost/Equity + NCL
Operating margin 10.93% 6.07%
= PBIT/Revenue (859+130+250)/11,333 (278+76+50)/6,654
Asset turnover 1.17 2.26
= Revenue/Capital employed 11,333/(4,598+5,078) 6,654/(1,945+1,001)
Budget Co has a better ROCE and is therefore making better returns for its investors. The
main cause of this is Budget Co’s ability to generate sales. For every $ of capital employed, it
generates $2.26 of sales revenue as compared to only $1.17 in the case of Flag Co. Budget Co
has much shorter flight times than Flag Co and therefore could be making more journeys and
spending less time parked at airports.
Budget Co earns a lower operating margin than Flag Co, as Budget Co’s operating costs as
percentage of revenue are 94% compared to Flag Co at 89%. This is probably due to Budget
Co’s pricing strategy. The lower operating margin is more than offset by Budget Co’s higher
asset turnover, resulting in a higher capital employed (asset turnover x operating margin =
ROCE, therefore 6.07% x 2.26 = 13.7%)
Analysis of the other information provided shows that Budget Co has a much higher seat
occupancy rate
Flag Co Budget Co
Seat occupancy rate 66.29% 95%
= Passenger seat kilometers/Available seat kilometers 14,201/21,423 x 100 14,206/14,952 x 100
This is probably a consequence of its low fares policy resulting in higher sales of seats relative
to Flag Co and therefore a higher asset turnover
Budget Co also appears more fuel efficient than Flag Co.
Flag Co Budget Co
Available seat kilometer per liter of fuel 8,802 12,001
= Available seat kilometers/Aviation fuel liters consumed 21,423/2.434 14,952/1.246

The better fuel economy is probably related to Budget Co’s newer fleet of aircraft. Better fuel
economy would tend to improve Budget Co’s operating margin, however, it is still lower than
Flag Co’s.
Liquidity
Flag Co Budget Co
Current ratio 0.6 0.79
= Current assets/Current liabilities 3,404/5,700 885/1,116
The current ratios of the two businesses are below the text book norm of 2:1, however, they
are both service companies which carry little inventory, so this is not surprising or worrying.
There is no apparent reason for the difference between the two companies.
Risk
Flag Co Budget Co
Capital employed 110.44% 51.47%
= Debt/equity 5,078/4,598 x 100 1,001/1,945 x 100
Interest cover 4.96 times 8.08 times
= PBIT/Interest (859+130+250)/250 (278+76+50)/50
Operating gearing 950% 820%
=
Flag Co has a relatively high level of long-term borrowings. This adds to the risks of the
business as interest on these borrowings has to be paid no matter the company’s operating
profit. At present, its operating profit is nearly five times larger than its interest bill and it
appears to be able to comfortably pay its commitments. Its operating gearing is 950%,
indicating that if sales volume fell by 10%, then its profit before interest and tax would fall by
95% (that is 950% or 9.5 times more). This would cause Flag Co difficulty in covering its
interest payments. As demand for business travel is very sensitive to economic conditions,
there is a strong probability that at some point Flag Co will experience a fall in sales volume.
As a result of its owner’s equity investment, Budget Co carries less financial gearing than Flag
Co and has better interest cover. Its operating gearing is slightly lower and given its relative
insensitivity to economic conditions, it can be considered a safer company than Flag Co.
(b) Briefly explain how Fitzgerald and Moon’s building block model could be used to manage the
performance of a service business
Fitzgerald and Moon’s building block model provides a framework for service companies to
design performance measurement systems which are linked to management rewards. It
provides a system of targets (standards) which will motivate managers to improve business
performance.
There are three building blocks in the model.
The first block gives six dimensions, meaning the aspects of performance which must be
measured in a service business. These are:
- Financial performance, for example, profitability and growth
 - Competitiveness which measures an organisation’s standing against its competition
- Quality of the service offered
- Flexibility of the organisation in providing the service
- Innovation which addresses the ability to introduce new processes and services
- Resource utilisation which measures productivity and efficiency
These six dimensions should be split into results (financial performance and competitiveness)
which are the outcomes of past decisions and determinants (quality, flexibility, innovation and
resource utilisation) which drive future performance and results.
The second block relates to setting standards. To motivate managers, it is important that they
take ownership of standards (that is accept or internalise them) and the standards appear
achievable and equitable (fair).
The third block relates to the rewards managers are offered for achieving the standards. These
must have clarity (the performance measurement scheme must be understood by managers),
they must be motivating (rewards must be attractive) and controllable (not subject to
influences outside the manager’s control).

March/July 2020 – Balanced scorecard

Scenario 2 (extract)
Extracts from TripEvent, an influential online customer forum:
‘I love Hammocks Co; the service and attention to detail is exemplary and the resorts are
always pristine. However, their competitor “Loungers” has full body driers, ionised water taps
and a range of professional haircare equipment in all their rooms.’
‘Our third time back to Hammocks Co this year and we continue to be amazed by the
wonderful level of service. One thing though is the menus don’t seem to have changed much
from one visit to the next.’
‘We booked Hammocks Co on the spur of the moment but then found that we couldn’t get a
flight. We called Hammocks Co administration centre to change our booking to another resort
where we could get a flight to and were told that it would not be a problem. However, it took
two more calls and three emails to get confirmation and then our credit card was charged twice
in error. Of course, it was eventually all resolved, the incorrect charge refunded, a
complimentary limousine provided to and from the airport and we received the most amazing
customer service at the resort, but it was frustrating at the time.’
‘When I made my booking I was assured that my bed would be made with the special anti-
allergenic bedding which I need for a good night’s sleep and that my favourite blend of tea
would be available. When I arrived, neither of these requirements were met. To be fair to
Hammocks Co though, everything was in order two hours later when I went to bed.’
Q (b)(i): Explain TWO advantages of Hammocks Co using the balanced scorecard approach
to performance management. (3 marks)
 Clarifying how the various classes of performance measure act together to produce
good financial performance. For example, the invoicing error, though essentially trivial
and eventually resolved to the customer’s satisfaction was an error in internal business
processes which marred the customer’s experience. The error was made public.
 Balancing long-term and short-term objectives. The menu is apparently successful but
hasn’t changed. Developing new offerings will require experimentation and will incur
immediate costs, but these should be recovered in the longer term.
Q (b)(ii): Suggest and justify ONE goal and TWO performance measures for each of the
TWO perspectives of the balanced scorecard which are not currently addressed by Hammock
Co’s objectives. (9 marks)
 The company has already addressed financial and customer perspectives so the answer
must address internal business process and innovation and learning perspectives
Internal business process perspective:
Goal: excellent administration so that specific arrangements made by customers (such as
special bedding) are communicated and acted on.
Measures:
 Reported errors, for example on feedback forms and web pages
 Delays in guests accessing rooms. This will indicate general housekeeping problems
and investigation might uncover that some delays are caused by administration errors.
Justification: guest comments have indicated that the administration department has made a
number of errors. Although not very serious, these errors do detract from customers’
perception of the business and hence its potential number of bookings and financial success.

Innovation and learning perspective:

Goal: to surpass competitors’ offerings on facilities and restaurant standards
Measures:
 Lists comparing competitors’ offerings to Hammock Co’s. This might require ‘mystery
shoppers’ visiting other vacation resorts and listing facilities then comparing those to
Hammock Co’s own.
 Frequency of menu changes.
Justification: guest comments have indicated that Hammock Co’s facilities are not as good as
some competitors’ and also that the menus seem staid and repetitive. If Hammock Co wants to
present itself to customers as a luxury resort it has to live up to its promise and compete
effectively by keeping up to date with trends and offering more variety on menus.
 Machining Assembly
Variable cost $6 $4
Transfer price $15 $15
Selling price $26
Contribution $9 $7
x 120,000 units $1,080,000 $840,000
Less: Fixed costs ($525,000) ($350,000)
Profit ($550,000) ($490,000)

Design Variable costs ($29 x 2,400 hours) 69,600

Fixed costs 56,160
125,760
Profit = 40% mark up 50,304
Cost to production section 176,064
Production Variable costs ($35 x 7,000) 245,000
Fixed costs 172,000
Total cost 593,064
Revenue ($90 x 7,000) 630,000
Profit 36,936
Increase in variable costs from buying in (2,200 units x $40 ($140 - $100)) = $88,000
Less the specific fixed costs saved if A shut down = (10,000)
Decrease in profit = $78,000
CHAPTER 15: PERFORMANCE MEASUREMENT
TIES ONLY CO
Ties Only Co is a new business, selling high quality imported men’s ties via the Internet. The
managers, who also own the company, are young and inexperienced but they are prepared to take
risks. They are confident that importing quality ties and selling via a website will be successful
and that the business will grow quickly. This is despite the well-recognised fact that selling
clothing is a very competitive business.
They were prepared for a loss-making start and decided to pay themselves modest salaries
(included in administration expenses in Table 1 below) and pay no dividends for the foreseeable
future.
The owners are so convinced that growth will quickly follow that they have invested enough
money in website server development to ensure that the server can handle the very high levels of
predicted growth. All website development costs were written off as incurred in the internal
management accounts that are shown below in Table 1.
Significant expenditure on marketing was incurred in the first two quarters to launch both the
website and new products. It is not expected that marketing expenditure will continue to be as
high in the future.
Customers can buy a variety of styles, patterns and colours of ties at different prices.
The business’s trading results for the first two quarters of trade are shown below in table 1.
Table 1
Quarter 1 Quarter 2
$ $ $ $
Sales 420,000 680,000
Less: Cost of Sales (201,600) (340,680)
Gross Profit 218,400 339,320
Less: Expenses
Website development 120,000 90,000
Administration 100,500 150,640
Distribution 20,763 33,320
Launch marketing 60,000 40,800
Other variable expenses 50,000 80,000
Total expenses (351,263) (394,760)
Loss for quarter (132,863) (55,440)

Required:
a. Assess the financial performance of the business during its first two quarters using only
the data in Table 1 above
Sales growth
Ties Only has had an excellent start to their business. From a standing start they have made
$420,000 of sales and then grown that figure by over 61% to $680,000 in the following quarter.
This is impressive particularly given that the clothing industry is very competitive. Equally it is
often the case that new businesses make slow starts, this does not look to be the case here.
Gross profit
The gross profit for the business is 52% for quarter 1 and 50% for quarter 2. Comparable
industry data is not provided so firm conclusions cannot be drawn. However, gross profit has
reduced by 2% in just one quarter. This is potentially serious and should not be allowed to
continue.
The cause of this fall is unclear, price pressure from competitors is possible, who may be
responding to the good start made by the business. If Ties Only were reducing its prices, this
would reflect on the gross profit margin produced.
It could also be that the supply side cost figures are rising disproportionately. As the business has
grown so quickly, it may have had to resort to sourcing extra new supplies at short notice
incurring higher purchase or shipping costs. These could all reduce gross margins achieved.
Website development
Website costs are being written off as incurred to the management accounting statement of profit
or loss. They should be seen as an investment in the future and unlikely to continue in the long
term. Website development has been made with the future in mind; future website costs may be
expected to be lower than at present. Taking this into consideration the loss made by the business
does not look as serious as it first appears.
Administration costs
These are 23.9% of sales in quarter 1 and only 22.1% of sales in quarter 2. This could be good
cost control, impressive given the youth and inexperience of the management team.
Also any fixed costs included in the cost (directors’ salaries are included) will be spread over
greater volume. This would also reduce the percentage of cost against sales figure. This is an
example of a business gaining critical mass. The bigger it gets the more it is able to absorb costs.
Ties Only may have some way to go in this regard, gaining a much greater size than at present.
Distribution costs
This is a relatively minor cost that again appears under control. Distribution costs are likely to be
mainly variable (postage) and indeed the proportion of this cost to sales is constant at 4.9%.
Launch marketing
Launch marketing is another cost that, although included in this statement of profit or loss, it is
unlikely to continue at this level. Once the “launch” is complete this cost will be replaced by
more general marketing of the website. Launch marketing will be more expensive than general
marketing and so the profits of the business will improve over time. This is another good sign
that the results of the first two quarters are not as bad as they seem.
Other costs
Another cost that appears under control in that it seems to have simply varied with volume.

b. Briefly consider whether the losses made by the business in the first two quarters are a
true reflection of the current and likely future performance of the business
Although the business has lost over $188,000 in the first two quarters of its life, this is not as
disastrous as it looks. The reasons for this view are:
- New businesses rarely breakeven within six months of launch;
 - The profits are after charging the whole of the website development costs, these costs
will not be incurred in the future;
- Launch marketing is also deducted from the profits. This cost will not continue at such a
high level in the future.
The major threat concerns the fall in gross profit percentage that should be investigated.
The owners should be relatively pleased with the start that they have made. They are moving in
the right direction and without website development and launch marketing they made a profit of
$47,137 in quarter 1 and $75,360 in quarter 2.
If sales continue to grow at the rate seen so far, the business (given its ability to control costs) is
well placed to return significant profits in the future.
The current profit (or loss) of a business does not always indicate a business’s future
performance.

c. The owners are well aware of the importance of non-financial indicators of success and
therefore have identified a small number of measures to focus on. These are measured monthly
and then combined to produce a quarterly management report.
The data for the first two quarters management reports is shown below:
Table 2

Quarter 1 Quarter 2

Website hits 690,789 863,492

Number of ties sold 27,631 38,857

On time delivery 95% 89%

Sales returns 12% 18%

System downtime 2% 4%
Notes:
A website hit is automatically counted each time a visitor to the website opens the home page of
Ties Only Co.
The industry average conversion rate for website hits to number of ties sold is 3.2%.
The industry average sales return rate for internet-based clothing sales is 13%
Comment on each of the non-financial data in Table 2 above taking into account, where
appropriate, the industry averages provided, providing your assessment of the
performance of the business
Website hits
This is a very impressive start. A new business can often find it difficult to make an impression
in the market. Growth in hits is 25% between the two quarters. If this continued over a year the
final quarter hits would be over 1.3m hits. The Internet enables new businesses to impact the
market quickly.
Number of ties sold
The conversion rates are 4% for quarter 1 and 4.5% for quarter 2. Both these figures may seem
low but are ahead of the industry average data. (Industry acquired data must be carefully applied,
although in this case the data seems consistent.) It appears that the business has a product that the
market is interested in. Ties Only is indeed looking competitive.
Average price achieved for the ties:
Quarter 1: $420,000/27,631 = $15.20 per tie
Quarter 2: $680,000/38,857 = $17.50 per tie
This suggests that the fall in gross profit has little to do with the sales price for the ties. The
problem of the falling gross profit must lie elsewhere.
On time delivery
Clearly the business is beginning to struggle with delivery. As it expands, its systems and
resources will become stretched. Customers’ expectations will be governed by the terms on the
website, but if expectations are not met then customers may not return. More attention will have
to be placed on the delivery problem.
Sales returns
Returns are clearly common in this industry. Presumably, ties have to be seen and indeed worn
before customers accept them as suitable. The concern here is that the business’s return rate has
jumped up in quarter 2 and is now well above the average for the industry. In other words,
performance is worsening and below that of the competitors. If the business is under pressure on
delivery (as shown by the lateness of delivery) it could be that errors are being made. If wrong
goods are sent out then disappointed customers will return them.
The alternative view is that the quality of the product is not what is suggested by the website. If
the quality is poor then unhappy customers could well return the products.
This is clearly concerning and an investigation is needed.
System down time
System down time is to be avoided by Internet based sellers as much as possible. If the system is
down then customers cannot access the site. This could easily lead to lost sales at that time and
cause customers not to try again at later dates. Downtime could be caused by insufficient
investment at the development stage or the site being is under pressure due to peaking volumes.
This second explanation is more likely in this case (as money was invested to build the server to
a high specification).
The down time percentage has risen alarmingly and this is concerning. Figures for the average
percentage down time achieved by comparable systems are needed to be able to comment
further.
The owners are likely to be disappointed given the level of initial investment they have already
made. A discussion with the website developers may well be warranted.
Summary: This new business is doing well. It is growing rapidly and ignoring non-recurring
costs is profitable. It needs to focus on delivery accuracy, speed and quality of product. It also
needs to focus on a remedy for the falling gross profit margin.
CHAPTER 18: TRANSFER PRICING
Bath Co
Bath Co specialises in the manufacture and sale of baths. Each bath consists of a main unit plus a
set of bath fittings. The company is split into two divisions, A and B. Division A manufactures
the bath and Division B manufactures sets of bath fittings. Currently, all of Division A’s sales are
made externally. Division B, however, sells to Division A as well as to external customers. Both
of the divisions are profit centres. The following data is available for both divisions:
Division A

Current selling price for each bath $450

Costs per bath:

Fittings from Division B $75

Other materials from external suppliers $200

Labour costs $45

Annual fixed overheads $7,440,000

Annual production and sales of baths 80,000 units

Maximum annual market demand for baths 80,000 units

Division B

Current external selling price per set of fittings $80

Current price for sales to Division A $75

Costs per set of fittings:

Materials $5

Labour costs $15

Annual fixed overheads $4,400,000

Maximum annual production and sales of sets of fittings 200,000 units

(including internal and external sales)

Maximum annual external demand for sets of fittings 180,000 units

Maximum annual internal demand for sets of fittings 80,000 units

 B chỉ sản xuất và bán tối đa 200,000 units. Internal demand = 80,000 units; External
demand = 120,000
The transfer price charged by Division B to Division A was negotiated some years ago between
the previous divisional managers, who have now both been replaced by new managers. Head
Office only allows Division A to purchase its fittings from Division B, although the new
manager of Division A believes that he could obtain fittings of the same quality and appearance
for $65 per set, if he was given the autonomy to purchase from outside the company. Division B
makes no cost savings from supplying internally to Division A rather than selling externally.
Required:
(a) Under the current transfer pricing system, prepare a profit statement showing the
profit for each of the divisions and for Bath Co as a whole. Your sales and costs figures
should be split into external sales and inter-divisional transfers, where appropriate ($’000)
Division A Division B Bath Co
Revenue:
External 36,000 (80,000 x $450) 9,600 (120,000 x $80) 45,600
Inter-divisional transfer 6,000 (80,000 x $75) *Tổng revenue 0
gồm tranfer pricing
Total 36,000 15,400 45,600
Variable costs
External material costs 16,000 (80,000 x $200) 1,000 ($5 x 200,000) 17,000
Inter-divisional transfer 6,000 (80,000 x $75)
Labor cost 3,600 (80,000 x $45) 3,000 ($15 x 200,000) 6,600
Total (25,600) (4,000) (23,600)
Fixed cost (7,440) (4,400) (11,840)
Profit 2,960 7,200 10,160

(b) Head Office is considering changing the transfer pricing policy to ensure maximisation of
company profits without demotivating either of the divisional managers. Division A will be
given autonomy to buy from external suppliers and Division B to supply external customers in
priority to supplying to Division A => B sản xuất hết external 180,000 units, còn lại 20,000 units
internal transfer. A nhận 20,000 units và buy externally 60,000 unit (thêm $65 variable cost per
unit)
Calculate the maximum profit could be earned by Bath Co if transfer pricing is optimised
Division A Division B Bath Co
Revenue:
External 36,000 (80,000 x $450) 14,400 (180,000 x $80) 50,400
Inter-divisional transfer 1,300 (20,000 x $75)
Total 36,000 15,700 50,400
Variable costs
External material costs 19,900 ($265 x 60,000 + 1,000 ($5 x 200,000) 20,900
$200 x 20,000)
Inter-divisional transfer 1,300
Labor cost 3,600 3,000 6,600
Total (24,800) (4,000) (27,500)
Fixed cost (7,440) (4,400) (11,840)
Profit 3,760 7,300 11,060
(c) Discuss the issues of encouraging divisional managers to take decisions in the interests
of the company as a whole, where transfer pricing is used. Provide a reasoned
recommendation of a policy Bath Co should adopt
- Divisional performance: metric decided by the company
- Simply be the profit for the period or depending on type of responsibility center
- Whatever metric, profit figure => keen to maximize their individual profits => not aware
of the decisions’ impact on the company as a whole
 Transfer pricing system take into account behavioral impact of the price charged
Divisional managers’ performance is assessed using a metric as decided by the company. This
may simply be the profit for the period, or, depending on the type of responsibility centre being
used, a metric such as residual income or return on capital employed. Whatever the metric being
used, the division’s profit figure is going to affect it and divisional managers are therefore going
to be keen to maximise their individual profits. By focusing on individual decisions, divisional
managers are often not aware of the impact of their decisions on the company as a whole. This
would particularly be the case where a decision which is in the best interests of the company
actually makes an individual division’s performance look worse.
The transfer pricing system in place needs to take into account the behavioural impact of the
prices being charged.
- Minimum transfer price B (spare capacity) = marginal cost of $20 per unit
- HOWEVER, B becomes worse off than before and the manager not like it meanwhile A
will not want to pay more than $65 that it can buy from outside the group
- Policy
 Ensure: (1) A prepared to buy 20,000 sets from B
(2) B prepared to sell them at $65 per set để B work at full capacity & B biết A
có thể obtain for $65 => not difficult for B to agree
 Also require divisions buy internally first to ensure (1) happens. Therefore, Bath’s
overall profit is maximized while ensuring that divisional manager do not be come
demotivated.
It can be seen from (b) that the best decision for Bath is that:
Division A buys 60,000 sets of fittings from an outside supplier and buys the remaining 20,000
sets of fittings from Division B in order to ensure that Division B is working to full capacity.
Division B sells as many fittings as possible externally, at $80 per set. Since the maximum
external demand is 180,000 units, Division B sells the remaining 20,000 sets to Division A. The
minimum transfer price that would be acceptable to Division B is its marginal cost of $20 per
unit, since it has spare capacity. However, using this transfer price, Division B becomes worse
off than before the autonomy was given and Division B’s manager will not like this. Division A
will not want to pay more than the $65 that it can buy from outside the group.
Bath’s policy therefore needs to ensure that, firstly, Division A’s manager is prepared to buy
20,000 sets of fittings from Division B and secondly, Division B is prepared to sell them at $65
per set. Since it is in Division B’s best interest to work to full capacity and the manager of
Division B knows that Division A can obtain fittings for $65 per set, it should not be difficult for
B to agree to sell to A at this price. A policy of negotiated transfer prices would achieve this
fairly quickly. However, Bath also needs to have a policy that divisions buy internally first,
where this would be in the best interests of the overall profitability of the company. This would
ensure that Division A buys the 20,000 sets of fittings from Division B. In this way, Bath’s
overall profit is maximised while also ensuring that divisional managers do not become
demotivated.

Current transfer price

VC 1
FC/unit =80,000/20,000=4
Total cost 5
Mark up @ 20% 6

‘$(000) Packaging Radio Group

Internal sales 20x6=120
External sales 20x220=4,400
Total sales 120 4,400 4,400
Internal transfer -120
VC -20 -2,400 -2,420
FC -80 -500 -580
Profit 20 1,380 1,400

‘$(000) Packaging Radio Group

Internal sales 20x4=80
External sales 20x220=4,400
Total sales 80 4,400 4,400

Internal transfer -80

VC -20 -2,400 -2,420
FC -80 -500 -580
Profit -20 1,420 1,400
The group profit stays the same.
Packaging makes a loss meanwhile Ratio earns more profit

‘$(000) Packaging Radio Group

Internal sales 0
External sales 20x220=4,400
Total sales 80 4,400 4,400

External purchase 20x(-4)=-80 -80

VC 0 -2,400 -2,400
FC -60 -500 -560
Profit -60 1,420 1,360
THE BALANCED SCORECARD
The People’s Bank is a bank based in the country of Nawkrei. It has a total of 65 branches across
the country and also offers online banking (access to services via computer) and telephone
banking (access to customer service agents over the telephone) to its customers. Recently, The
People’s Bank also began offering its customers a range of mobile banking services, which can
be accessed from customers’ smartphones and tablet computers. Its customer-base is made up of
both private individuals and business customers. The range of services it offers includes:
Current accounts
Savings accounts
Credit cards
Business and personal loans
Mortgages (loans for property purchases)
The People’s Bank’s vision is to be “the bank that gives back to its customers” and their purpose
is “to help the people and businesses of Nawkrei to live better lives and achieve their ambitions”.
In order to achieve this, the bank’s values are stated as:
1. Putting customers’ needs first, which involves anticipating and understanding customers’
needs and making products and services accessible to as many customers as possible. The
People’ Bank has recently invested heavily in IT security to prevent fraud and also invested
to make more services accessible to disabled and visually impaired customers
2. Making business simple, which involves identifying opportunities to simplify activities and
communicating clearly and openly
3. Making a difference to the communities they serve, which involves primarily helping the
disadvantaged and new homeowners but also supporting small and medium-sized businesses
(SMEs) and acting fairly and responsibly at all times
Extracts from The People’s Bank’s balanced scorecard are shown below:

Performance measure 20X6 20X6

Actual Target

Financial perspective

Return on capital employed (ROCE) 11% 12%

Interest income $7.5m $7m

Net interest margin (margin achieved on interest income) 2.4% 2.5%

Amount of new lending to SMEs $135m $150m

Customer perspective
 Number of first-time homebuyers given a mortgage

by The People’s Bank 86,000 80,000

Number of complaints (per 1,000 customers) 1.5 2

Number of talking cashpoints installed for the visually

impaired 120 100

Number of wheelchair ramps installed in branches 55 50

Internal processes

Number of business processes within The People’s Bank

re-engineered and simplified 110 100

Number of new services made available through mobile

banking 2 5

Incidences of fraud on customers’ accounts or credit cards

(per 1,000 customers) 3 10

Total carbon dioxide emissions (tonnes) 430,000 400,000

Learning and growth

Number of colleagues trained to provide advice to SMEs 1,300 1,500

Number of hours (paid for by The People’s Bank) used

to support community projects 1,020,000 1,000,000

Number of trainee positions taken up by candidates

from Nawkrei’s most disadvantaged areas 1,990 2,000

Number of community organisations supported (either

through funding or by volunteers from The People’s Bank) 7,250 7,000

Required:
a. Explain why the balanced scorecard approach to performance measurement is more
useful to measure performance for The People’s Bank than a traditional approach using
solely financial performance measures
 - Financial performance & Non-financial performance: competitive => customers’ need
changes => specific categories => address these permits
- PM whether the Bank is being successful in pursuing their vision can be incorporated
- Measure long-term aspects of the future success
The balanced scorecard approach looks not only at the financial performance but also non-
financial performance. In order to maintain a competitive edge, organisations have to be very
aware of the changing needs of their customers. In the case of The People’s Bank, this has
involved identifying specific categories of customers which have particular needs, like SMEs in
a commercial context, or like the disabled or visually impaired in a non-commercial context.
This permits these needs to be addressed.
The People’s Bank has a vision and strategy which goes far beyond just making money. They
want to help the community and disadvantaged people and give something back to customers
also. Hence, by using the balanced scorecard, performance measures which address whether the
Bank is being successful in pursuing their vision can be incorporated.
In addition, from a purely business perspective, if employees and customers are valued and
internal processes are efficient, an organisation should have more chance of achieving long-term
success anyway. So, even putting aside the social objectives The People’s Bank has, the
balanced scorecard can be useful to The People’s Bank to measure these other aspects of future
success too.

b. Using all of the information provided, including The People’s Bank’s vision and values,
discuss the performance of The People’s Bank in 20X6
Financial perspective
- Overall: mixed success
- ROCE: target 12%, only achieved 11% => investment made in IT, but still a good idead:
pursue vision & keep customer happy & prevent future fraud
- Interest income: higher => offering better interest rates to customers than competing
banks as the interest margin achieved slightly lower
- Amount of new lending to SME: failure to meet target => insufficient number of staff
trained
The People’s Bank has had a year of mixed success when looking at the extent to which it has
met its financial targets. Its return on capital employed (ROCE) shows how efficiently it has used
its assets to generate profit for the business. The target for the year was 12% but it has only
achieved an 11% return. The People’s Bank’s interest income, however, was in fact $0.5m
higher than its target, which is good. This may have been achieved by offering slightly better
interest rates to customers than competing banks, as the interest margin The People’s Bank
achieved is slightly lower than target. The most likely reason for the under target ROCE is
therefore probably the investment which The People’s Bank has made in IT security and
facilities for the disabled and visually impaired. Whilst this may have reduced ROCE, this
investment is essentially a good idea as it helps The People’s Bank pursue its vision and will
keep customers happy. It will also, in the case of the IT security investment, prevent the bank
and its customers from losing money from fraud in the future.
The other performance measure, the amount of new lending to SMEs, is a little disappointing,
given The People’s Bank’s stated value of making a difference to communities. The failure to
meet this target may well be linked to having an insufficient number of staff trained to provide
advice to SMEs and, consequently, fewer of them may have been successful in securing
additional finance.
Customer perspective
- Provide mortgages to new homeowners: exceed => pursue vision
- Customer complaints: beat target => improved processes at the bank/ỉmproved security
- Help the disabled and visually impaired => good for reputations & stated value
With regard to its customers, The People’s Bank has performed well in the year. It has exceeded
its target to provide mortgages to new homeowners by 6,000. This is helping The People’s Bank
pursue its vision of helping new homeowners. It has also managed to beat the target for customer
complaints such that there are only 1.5 complaints for every 1,000 customers, well below the
target of 2. This may be as a result of improved processes at the bank or improved security. It is
not clear what the precise reason is but it is definitely good for The People’s Bank’s reputation.
The bank has also exceeded both of its targets to help the disabled and visually impaired, which
is good for its reputation and its stated value of making services more accessible.
Internal processes
- Process simplified: exceed target => good, lower customer complaints levels
- Investment to improve IT system => less incidences of fraud
- Only 2 new services available instead of 5
- New systems prevented business from keeping its CO2 emissions to target level
The number of processes simplified within the bank has exceeded the target, which is good, and
the success of which may well be reflected in the lower customer complaints levels. Similarly,
the investment to improve IT systems has been a success, with only three incidences of fraud per
1,000 customers compared to the target of 10. However, perhaps because of the focus on this
part of the business, only two new services have been made available via mobile banking,
instead of the target of five, which is disappointing. Similarly, it is possible that some of the new
systems have prevented the business from keeping its CO2 emissions to their target level.
Learning and growth
- Hours of paid volunteer work & No. Community organization supported: exceed =>
additional costs, not meet target for ROCE
- Helping small businesses & the disadvantagesd: not quite met targets => shortfall in
training of employees to give advice to SMEs
- Trainee positions: missed target, no. of candidates not as high as planned + no control
The People’s Bank has succeeded in helping the community, exceeding both of its targets
relating to hours of paid volunteer work and number of community organisations supported by
volunteers or funding. These additional costs could have contributed to the bank not quite
meeting its target for ROCE.
However, the bank has not quite met its targets for helping small businesses and helping the
disadvantaged. As mentioned earlier, the shortfall in training of employees to give advice to
SMEs may have contributed to The People’s Bank’s failure to meet its target lending to SMEs.
As regards the percentage of trainee positions, the target was only just missed and this may well
have been because the number of candidates applying from these areas was not as high as
planned and the bank has no control over this.
Overall, the bank has had a fairly successful year, meeting many of its targets. However, it still
has some work to do in order to meet its stated values and continue to pursue its vision.

Jamair was founded in September 2007 and is one of a growing number of low-cost airlines in
the country of Shania.
Jamair’s strategy is to operate as a low-cost, high efficiency airline, and it does this by:
- Operating mostly in secondary cities to reduce landing costs
- Using only one type of aircraft in order to reduce maintenance and operational costs.
These planes are leased rather than bought outright
- Having only one category of seat class
- Having no pre-allocated seats or in-flight entertainment
- Focusing on e-commerce with customers both booking tickets and checking in for flights
online.
The airline was given an ‘on time arrival’ ranking of seventh best by the country’s aviation
authority, who rank all 50 of the country’s airlines based on the number of flights which arrive
on time at their destinations. 48 Jamair flights were cancelled in 2013 compared to 35 in 2012.
This increase was due to an increase in the staff absentee rate at Jamair from 3 days per staff
member per year to 4.5 days.
The average ‘ground turnaround time’ for airlines in Shania is 50 minutes, meaning that, on
average, planes are on the ground for cleaning, refuelling, etc for 50 minutes before departing
again. Customer satisfaction surveys have shown that 85% of customers are happy with the
standard of cleanliness on Jamair’s planes.
The number of passengers carried by the airline has grown from 300,000 passengers on a total of
3,428 flights in 2007 to 920,000 passengers on 7,650 flights in 2013. The overall growth of the
airline has been helped by the limited route licensing policy of the Shanian government, which
has given Jamair almost monopoly status on some of its routes. However, the government is now
set to change this policy with almost immediate effect, and it has become more important than
ever to monitor performance effectively.
Required:
(a) Describe each of the four perspectives of the balanced scorecard. (6 marks)
- Financial perspective – concerned with how a company looks to its shareholders. How
can it create value for them? There are three core financial themes which will drive the
business strategy: revenue growth and mix, cost reduction and asset utilisation.
- Customer perspective – considers how the organisation appears to customers. It should
identify the customer and market segments in which the business will compete. There is a
strong link between the customer perspective and the revenue objectives in the financial
perspective. If customer objectives are achieved, revenue objectives should be too.
- Internal perspective – requires the organisation to ask itself: ‘what must we excel at to
achieve our financial and customer objectives?’ It must identify the internal business
processes which are critical to the implementation of the organisation’s strategy. These
will include the innovation process, the operations process and the post-sales process.
- Learning and growth perspective – requires the organisation to ask itself whether it can
continue to improve and create value. The organisation must continue to invest in its
 infrastructure – i.e. people, systems and organisational procedures – in order to improve
the capabilities which will help the other three perspectives to be achieved.
(b) For each perspective of the balanced scorecard, identify one goal together with a
corresponding performance measure which could be used by Jamair to measure the
company’s performance. The goals and measures should be specifically relevant to Jamair.
For each pair of goals and measures, explain why you have chosen them.
Financial perspective
- Fewer planes: Lease costs of plane per customer => operating efficiency (cover the cost)
- Increase seat revenue per plane: Revenue per available passenger mile => operating
efficiency

Customer perspective
- Flight on time: ranking from authority => currently 7th, customer more likely to use =>
increase revenue
- Reduce the number of flights cancelled: the number of flights cancelled => if flights are
seen to be cancelled frequently => customer will not want to use it, need to be reliable

Internal perspective
- Improve turnaround time on the ground: on the ground time => less time spent on the
ground means fewer planes are needed => reduce plane leasing costs
- Improve the cleanliness of planes: % of customer happy as reported in surveys => only
85%, can cause loss of revenue
- Develop the online booking system: % downtime => relies entirely on the booking
system, critical it can deal with growing number of customers
Innovation and growth

- Reduce the employee absentee rate: number of days absent per employee => workforce
reliable, at worse, absent staff lead to cancelled flights
- Increase ground crew training on cleaning and refueling procedures: number of days’
training per ground crew member => better trained, reduce time plane stays on the
ground => fewer planes required, lower costs + better cleaning => higher customer
satisfaction