ACCA Paper F5 Performance Management. Mock Exam. Commentary, marking scheme and suggested solutions

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1 ACCA Paper F5 Performance Management Mock Exam Commentary, marking scheme and suggested solutions

2 Commentary Tutor guidance on improving performance on the exam paper. General Your script is the only evidence you will provide to convince an ACCA marker that you should pass this paper and therefore progress through your qualification. Even very talented students can fall down at this paper because they do not consider the following points: The first question should be the question you feel most comfortable with. Give the marker the impression that you are comfortable with the syllabus as early as possible. Make it clear which question it is you are answering too! Make sure you answer ALL section A and section B questions even if you have to guess. It is amazing how a 'lucky guess' can generate the 50th mark the one you need to pass there is no negative marking so you have nothing to lose. Q31 Greenloch City Council This question covers zero based budgeting and incremental budgeting. Parts (a) and (b) are relatively straightforward, as you should be able to discuss both styles of budgeting at this level. Part (c) is more specific to the scenario. Don't worry too much about giving the correct advice, the important part here is to back up your recommendation by referencing the specific needs of Greenloch City Council. Q32 The Machinery Group This is a transfer pricing question which requires very specific application to the scenario. Students tend have difficulty with the area of transfer pricing, and this has been noted in examiner reports, therefore it is very likely to be examined regularly. Make sure that you practise lots of transfer pricing questions so that you can deal with every permutation of this type of question, which is a very important topic for F5. 2

3 Section A Solutions 1 B ABC can be used in service businesses and it is a form of absorption costing. 2 A 25% $200,000 = $50,000 Return per unit = 50,000/500 = $100 3 D The aim should be to minimise the time when costs are incurred on a product that is not yet on the market (so minimise time to market) and to minimise the breakeven time or payback period for the investment. The aim should be to maximise return, and returns should be maximised for products with a longer commercial life. 4 A Classifying environmental costs as a production overhead hides them and makes them difficult to control. Therefore they should be considered separately. Understanding these costs can lead to process improvements and enhance profitability if it forms part of the organisation's strategy. 5 C Material D valued at current purchase price because it is in regular use it is assumed that items taken from inventory would be replace. Current purchase price: $ kgs = $975 Material E valued at lost scrap proceeds, as it would be sold if it was not going to be used on the contract. Lost scrap: $ $90 6 A Breakeven revenue = 100,000/0.25 = $400,000 MoS = $525, ,000 = $125,000 Number units = 125,000/20 = 6,250 7 B In the original budget, contribution is maximised when both resources are fully utilised, so that: 0.5x + y = 2,000, and 2x + 1.5y = 4,000. If the number of available machine hours increases to 2,001, contribution will be maximised where: (1) 0.5x + y = 2,001 and (2) 2x + 1.5y = 4,000 Multiply (1) by 4 (3) 2x + 4y = 8,004 Subtract (2) from (3) 2.5y = 4,004; therefore y = 1,601.6 Substitute in (1) 0.5x + 1,601.6 = 2,001; therefore x = Total contribution = (1,601.6 $6) + (798.8 $5) = $13,603.6 Shadow price of machine time = $13,603.6 $13,600 = $3.60 per machine hour 8 B b = 15/200 = when p = 73.5 and q =1, = a (1, ) a = Demand function p = Q 3

4 9 C Spreadsheet models are quantitative models and do not include qualitative items. Errors in a large spreadsheet model can be very difficult to trace when they occur. Several individuals may work on a spreadsheet model, but they should not do so simultaneously. When a large number of different versions of a draft budget are prepared, there may be problems with identifying each version and recognising the assumptions in which each version has been produced. 10 A Whereas control through feedback is based on a comparison of budgeted and actual (historical) results, feedforward control is based on a comparison of budgets or targets with current forecasts or future expectations. Incremental budgeting is budgeting based on 'last year's budget' or 'last year's actual results', making adjustments for known differences in the future. If is a method of budgeting where wasteful spending or budgetary slack is common and difficult to eliminate. 11 C Participative budget takes longer than top-down budgeting because of the length of time needed for discussions and negotiations between the budget participants. With top-down budgets, decisions can be made without the need for lengthy consultations. Although participative budgeting involves managers at lower levels within the organisation, senior management make the final decisions, and management must still accept budget responsibilities for the aspects of operations under their control and direction. A 'blame' culture may exist in any organisation when things go wrong. However it is probably more likely to exist when budget targets have been imposed by senior management, so that managers can deny responsibility and put the blame for poor performance on to something or someone else. 12 D In target costing, the target cost is based on the selection of a target selling price. Raising the selling price would be an inappropriate measure because it would undermine the purpose of target costing. Unlike lifecycle costing, target costing does not usually measure product development costs within the target cost, because development work is already under way. The target cost gap might be reduced by using standard components where possible, rather than non-standard components (which tend to be more expensive/costly). Removing non-value-added features from the product design should reduce costs without reducing the value of the product to the customer. 13 A A problem is to decide whether the usage operational variance should be priced at the original standard price of $3 per kg or the revised standard price of $2.50. It should be priced at the same rate as the material usage planning variance. kg Original standard usage per unit 4.0 Revised standard usage per unit 4.5 Usage planning variance per unit 0.5 Adverse Actual production Usage planning variance in total 1,800 units 900 kg Adverse The rate used to calculate the variance s therefore $2,700/900 = $3, which is the original standard price per kg. Operational usage variance kg 1,800 units of output should use ( 4.5) 8,100 They did use 8,300 Usage planning variance in kg 200 Adverse Original standard price per kg $3 Usage planning variance in kg $600 (A) 4

5 14 C ROI = 20% Capital employed $4 million Therefore divisional profit = $800,000 Notional capital charge = 9% $4 million = $360,000 Residual income = $800,000 $360,000 = $440, D There should be more than one target and KPI for each of the four perspectives, to create balance and avoid over-emphasis on just one measure. The four aspects of performance may sometimes conflict with each other for example there may be a conflict between innovation and learning for the longer term and short-term financial performance. Compromises between the targets for each of the four perspectives may therefore be necessary; however, the selected targets for the four perspectives must all be consistent with each other. 5

6 Section B 16 B Factory cost per hour = (Labour + overheads ) / Number of hours Labour + overheads = $18,000 + $15,000 = $33,000 Factory cost per hour = $33,000 / 5,000 = $ B Total throughput = sales materials = $63,000 - $18,750 = $44,250 Return per hour = $44,250 / 5,000 = $8.85 Cost per hour = $9.50 TPAR = return per hour / cost per hour = $8.85 / $9.50 = B (1) and (2) only Division Z's TPAR is less than 1 and this means that its costs are greater than its return and this is not therefore a viable position. Statement (1) is therefore true. Stricter cost control and cost reduction initiatives would help to improve this ratio. These could include: sourcing alternative cheaper suppliers, using cheaper labour or better trained labour that will be more efficient. Statement (2) is therefore true. An increase in selling price would increase the TPAR but care would need to be taken here. If a rise in selling price results in a loss in quantity of units sold this may not be a wise move. Statement (3) is therefore false. Division Z could look to improve its TPAR by reducing its inventory and therefore reducing purchases. So statement (4) is false. 19 A The throughput approach is based on throughput maximisation. Throughput is defined as sales less direct materials. Z1 Z2 $ $ Sales price Less: direct materials (10) (15) Throughput per minute of bottleneck resource is: $ $ 40/12 = /16 = $3.125 Contribution is maximised by producing 40 units of Z1, the maximum number of Z1 that can be produced, given the bottleneck resource of skilled labour. 20 A Throughput assumes that all costs except direct materials are fixed in the short run. In throughput accounting, all operational expenses or factory expenses are assumed to be 'fixed' costs. B is false. A JIT environment is used with throughput accounting. C is false. Throughput accounting values inventory at material cost only. D is false. Efficiency requires schedule adherence and meeting delivery dates. Traditional product costing bases efficiency on labour and machines working to full capacity. 6

7 21 D Maximin identify the worst outcome for each level of production and choose the highest of these worst outcomes. No of tubs of frozen yoghurt produced 10,000 8,000 4,000 Worst outcome (300) 200 1,200 The highest of these is $1,200 therefore choose to produce 4,000 tubs to meet demand predicted in the event of poor market conditions. Maximax identify the best possible outcome for each level of supply and choose the highest of these best outcomes No of tubs of frozen yoghurt produced 10,000 8,000 4,000 Best outcome 3,000 2,400 1,200 The highest of these is $3,000 therefore choose to produce 10,000 tubs to meet the demand predicted in the event of good market conditions. 22 A The minimax regret approach is used by a decision maker who reflects on decisions after the fact and complains about their decisions when they consider the profits they could have had if they had made a different choice. 23 B $1,200 and 8, C Expected value use the probabilities provided in order to calculate the expected value of each of the supply levels. Production of 10,000 tubs. EV = (0.2 3,000) + (0.5 1,900) ( ) = $1,460 Production of 8,000 tubs. EV = (0.7 2,400) + ( ) = $1,740 Production of 4,000 tubs. EV = 1,200 1 = $1,200 The expected value of producing 8,000 tubs is the highest at $1,740 and therefore this production level should be chosen. Forecast demand 25 A 1 only. Number of tubs chosen EV of contribution $ Probability Contribution $ Good 20% 10,000 3, Average 50% 8,000 2,400 1,200 Poor 30% 4,000 1, ,160 It's true that perfect information is guaranteed to predict the future with 100% accuracy. Statement 2 is false. Perfect information can be used for decision making purposes because it removes the risk associated with the decision by predicting the future with certainty in advance. 26 C The correct answer is hours Cumulative average time per batch for the first 25 batches Y = ax b Where Y = the cumulative average time per unit to produce x units x = the cumulative number of units a = the time taken for the first unit of output b = the index of learning (loglr/log2) 7

8 The cumulative average time per batch, with a learning curve of 80% is therefore Y = ax where a = the time for the first batch (600 hours) and X is the number of the batch. For the 25 th batch, X = 25. Y = = = The cumulative average time per batch for the first 25 batches is hours. 27 C The correct answer is hours. Time taken for the 25 th batch The cumulative average time per batch for the first 24 batches is Y = = = Hours Total time for 1 st 25 batches ( ) 9, Total time for 1 st 24 batches ( ) 8, th batch A Feedforward control is control based on forecast results. In other words if the forecast is bad, control action is taken well in advance of actual results. Negative feedback indicates that results or activities must be brought back on course, as they are deviating from the plan. Positive feedback results in control action continuing the current course. Double loop feedback is information used to change the plan itself. For example, if sales targets are not reached, the company may need to change the plan. 29 B Disseminating information more widely than necessary has a cost. Even if the cost of sending out the information electronically is low, it wastes time for the people receiving it who do not need it. The costs of time inputting data and correcting data, and gathering the same information more than once are all examples of the cost of inefficiency in data collection rather than information use. 30 A Statement (1) is true. This is the formula for 'b', the learning index. Statement (2) is true. For example, if labour take 100 minutes to do something, a 90% learning curve will mean that they then take 90 minutes. An 80% learning curve means that they then take 80 minutes (ie less time than 90 minutes). So you can see that 80% means quicker learning than 90%. Statement (3) is false. This is one of the limitations of learning curve theory. 8

9 Section C 31 Greenloch City Council Marking scheme Marks (a) Stages in zero-based budgeting (1-2 marks per point made) 5 (b) Advantages and disadvantages of (1-2 marks per point. Max 3 marks per advantage and disadvantage) (i) Incremental budgeting (ii) Zero based budgeting (c) Recommendation 1 mark per relevant point Suggested solution (a) Zero based budgeting involves three main stages. 1 Defining activities: Management identify the key activities within the organisations and describe them within a decision package. The decision package shows the minimum level of resource required to meet the organisations objectives. Incremental packages may be prepared to show any additional work that could be done, at what cost and for what benefit. 2 Evaluate and rank each activity: Management will then rank each activity on the basis of its benefit to the organisation. Minimum work requirements are given high priority and so too will work which meets legal obligations. This will help management decide what to spend and where to spend it. This ranking of the decision packages happens at numerous levels of the organisation. For example, the head of the sanitation department will rank the numerous decision packages that he prepares. Then, the mayor, or head of finance will rank the catering packages amongst all the packages prepared for the rest of Greenloch City Council. 3 Allocate resources: This is the final stage, whereby management allocate resources in the budget according to the funds available and the evaluation and ranking of the competing packages. (b) (i) Advantages of incremental budgeting: As well as being easy to prepare, it is easy to understand. Prevents conflict between departmental managers since a consistent approach is adopted throughout the organisation. Disadvantages of incremental budgeting: It assumes that all current activities and costs are still needed, without examining them in detail. With incremental budgeting, the heads of department do not have to justify the existing costs at all. By its very nature, incremental budgeting looks backwards rather than forwards. While this is not such a problem is fairly stable businesses, it will cause problems in rapidly changing business environments. 9

10 (c) (ii) There is often no incentive to reduce costs. In fact, the heads of department in Greenlock City Council may find that if they do not spend their allocated budget, that their budgets will be cut the following year. This can result in spending money for the sake of it, and can be very wasteful. Advantages of zero based budgeting (ZBB): By its nature, it encourages a bottom-up approach to budgeting in order for ZBB to be used in practice. This should encourage motivation of employees. Since ZBB does not assume that last year's allocation of resources is necessarily appropriate for the current year, all of the activities of the organisation are reevaluated annually from a zero base. Most importantly therefore, inefficient and obsolete activities are removed, and wasteful spending is curbed. This has got to be the biggest benefit of zero-based budgeting compared to incremental budgeting and was the main reason why it was developed in the first place. It challenges the status quo and encourages a questioning attitude among the heads of department. Disadvantages of zero based budgeting (ZBB): The major limitation of ZBB is the volume of extra paperwork created. Assumptions about costs and benefits in each activity must be continually updated and new activities must undergo the same scrutiny as they occur within the organisation. The ranking process can be very difficult. Many packages may prove to be equally important for legal or operational reasons. It can also be difficult to compare activities with qualitative rather than quantitative benefits. The heads of department may not have the appropriate skills to construct design packages, and the management information systems might not be able to provide the necessary information. ZBB may therefore require a systems upgrade, as well as additional training, which may be very expensive and time consuming. Incremental budgeting is quick and easy to do and easily understood. However, the use of incremental budgeting gives rise to inefficiency and budgetary slack. Since ZBB requires all costs to be justified, it can seem inappropriate to use it for the entire budgeting process in a large organisation. Why take so much time and resources justifying costs that must be incurred in order to meet the basic needs of the citizens of Greenloch? In addition, it makes little sense to use such a long-winded process for costs where no discretion can be exercised anyway. However, for public sector bodies, whose key performance indicators are not as clear as commercial enterprises, it is important to regularly evaluate the value that the City Council brings to the citizens of Greenloch through the provision of services. ZBB forces departmental managers to justify their spending and present a case for the continuation of budget funding for each of its services. In conclusion, neither budgeting method provides the perfect tool for planning coordination and control. However, ZBB is considered more appropriate for public sector organisations where the majority of costs are discretionary and the emphasis is placed on obtaining value for money. Therefore I recommend that Greenloch City Council use a zero based budgeting system. 10

11 32 The Machinery Group Marking scheme (a) (i) Management friction 1 Spare capacity 1 Profit shifting 1 Loss of orders 1 Sub optimal decision making 1 Marks 5 (ii) Market price 1 Adjusted market price for external factors Calculations of market price Variable cost Calculation of variable cost Total transfer price (b) Explanation of relevant factors (2 marks each) 4 20 Suggested solution (a) (i) Allowing the managers of each company or division to negotiate transfer prices with each other is likely to have a number of behavioural implications. The current pricing policy does not benefit the group as a whole. Y Co recently missed out on a potentially profitable order due to high transfer prices charged by X Co. If X Co agreed to lower prices for components sold to Y, it is likely that Y Co could pass this on to customers in the form of lower prices and thus win more orders. The current policy also appears to favour X Co over Y Co which is likely to create friction between the managers of each company. The manager of X Co argues that the prices he charges Y Co are fair because if the internal sales were not made, he could increase external sales. This is not strictly true since X Co would have spare capacity if it did not sell to Y. (ii) Market price basis Unsatisfied external demand for X Co is estimated at 20%. As such, it is reasonable that X Co supplies some components to Y Co at the market price. Y Co may be able to negotiate a discount on the market price, given that selling internally effectively saves X Co administration and distribution costs incurred on external sales. The $400,000 of external sales by X Co represent 80% of the external market, so the unsatisfied demand equals 20/80 $400,000 = $100,000. It would be reasonable for X Co to sell the components to Y Co for, (say), $95,000. The $5,000 discount takes account of the cost savings for X Co mentioned above. 11

12 (b) Variable cost basis The remaining supplies to Y Co should be on a variable cost basis. Y Co may offer a slightly higher price as an incentive for X to produce the components. X Co's variable costs are 60% of cost of sales. ($250,000 60% = $150,000). This is 20% of the total sales figure of X Co. ($150,000 $750,000 = 20%). Therefore, the variable cost is 20% of the sales value. Once you remove the internal sales which are made on a market price basis less the discount, the remaining sales to be negotiated amount to $250,000. The remaining $250,000 of internal sales should be sold to Y Co for $250,000 20% = $50,000, plus a small incentive ($5,000) = $55,000. In this instance, the total value of internal sales from X Co to Y Co would be approximately $150,000. Goal congruence The transfer price, if possible, should encourage profit centre managers to agree on the amount of goods and services to be transferred, which will also be at a level that is consistent with the aims of the organisation as a whole such as maximising company profits. Constraints and demand Transfer prices should reflect capacity constraints and market demand for the item being transferred. The supplier's opportunity cost should be reflected in the transfer price. 12

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15 Student self-assessment Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use this as a basis to focus your future study on effectively improving your performance. Common problems Future emphasis if you answer Yes Timing and planning for all Sections Did you miss out any questions? Y/N Attempt all questions. For multiple choice questions in Sections A and B, it is worth making a guess at the correct answer. Did you finish too early? Y/N Make sure you deal with all the information given in the questions. Use the extra time to go back over your answers. Did you overrun? Y/N Focus on allocating your time better. Practise questions under strict timed conditions. If you get behind leave space and move on. Content in all Sections Did you struggle with: Interpreting the questions? Y/N Learn the meaning of question words (inside front cover). Learn subject jargon (study text glossary). Read questions carefully noting all the parts. Practise as many questions as possible. Understanding the subject? Y/N Review your notes/text. Work through easier examples first. Contact a tutor for help. Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop your memory as well as your understanding of a subject. Layout in Section C Was your answer difficult to follow? Y/N Use headings and subheadings. Use numbering sequences when identifying points. Leave space between each point. Did you fail to explain each point? Y/N Show why the point identified answers the question set. Did you include irrelevant information? Y/N Were some of your workings unclear? Y/N Focus on developing a logical structure to your answer. Give yourself time and space to make the marker's job easy. 15

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