ACCA Paper F5 Performance Management Class Notes December 2011
The Accountancy College Ltd, June 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of The Accountancy College Ltd. 2 www.studyinteractive.org
Contents PAGE INTRODUCTION TO THE PAPER 5 FORMULAE PROVIDED IN THE EXAMINATION PAPER 7 CHAPTER 1: COST ACCOUNTING AND NEW DEVELOPMENTS 9 CHAPTER 2: DECISION MAKING AND LINEAR PROGRAMMING 31 CHAPTER 3: PRICING 55 CHAPTER 4: DECISION MAKING UNDER UNCERTAINTY 69 CHAPTER 5: BUDGETING TYPES 83 CHAPTER 6: BUDGETARY CONTROL 91 CHAPTER 7: QUANTITATIVE AIDS TO BUDGETING 103 CHAPTER 8: STANDARD COSTING AND VARIANCE ANALYSIS 121 CHAPTER 9: ADVANCED VARIANCE ANALYSIS 139 CHAPTER 10: PERFORMANCE EVALUATION 153 CHAPTER 11: TRANSFER PRICING 175 APPENDIX: SOLUTIONS TO EXERCISES AND EXAMPLES 183 www.studyinteractive.org 3
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Introduction to the paper www.studyinteractive.org 5
INTRODUCTION TO THE PAPER AIM OF THE PAPER To develop knowledge and skills in the application of management accounting techniques to quantitative and qualitative information for planning, decision-making, performance evaluation and control. OUTLINE OF THE SYLLABUS 1. Cost accounting techniques. 2. Decision-making techniques including risk and uncertainty. 3. Budgeting techniques and methods. 4. Standard costing systems. 5. Performance appraisal including financial and non-financial measures. FORMAT OF THE EXAM PAPER FAQs The syllabus is assessed by a three hour paper-based examination. The examination consists of 5 questions of 20 marks each. All questions are compulsory. How has the exam format changed and what impact will that have on the paper? The paper has moved to having five 20 mark questions rather than four 25 mark questions. This move has been, it appears, to improve pass rates. Initial evidence would suggest that this will be the case. The questions will become less complex and there will be less emphasis on the discursive elements of answers and more emphasis on computation. The downside for students is that there will be more time pressure due to the fact that five separate scenarios must be understood during the limited time of the exam. On balance this is a good thing for students in future diets. What is the skills set that a student must bring to the paper? As a student approaching this paper the basic requirement is an ability to understand and compute the differing techniques and methods in the syllabus. In addition there is a need to understand the scenario and critically be able to write in relation to the scenario and whatever the numbers you have already calculated. What impact will there be of having a new examiner on this paper? There should be little or no impact of having a new examiner on the well prepared student. The style and content of the questions will change to some degree but the new examiner is given the same remit as the previous examiner. 6 www.studyinteractive.org
Formulae provided in the examination paper www.studyinteractive.org 7
FORMULAE & TABLES PROVIDED IN THE EXAMINATION PAPER FORMULAE SHEET Learning curve Y ax b Where: y = average cost per batch a = cost of first batch x = total number of batches produced b = learning factor (log LR/log 2) LR = the learning rate as a decimal Regression analysis y a bx r b n xy x y n x 2 x 2 a y b x n n n xy x y n x 2 x 2 n y 2 y 2 Demand curve P a bq b change in price change in quantity a price when Q 0 8 www.studyinteractive.org
Chapter 1 Cost accounting and new developments www.studyinteractive.org 9
CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS CHAPTER CONTENT DIAGRAM Costing methods Absorption Activity Other costing costing based costing methods H Full cost per unit H Accurate product H Life cycle costing costs H Issue: Arbitrary H Target costing cost allocation H Swap cost units with cost pools H Solution: Activity based costing H Swap OARs with cost driver rates Throughput accounting Environmental Accounting H Return per factory hour H Costing methods H Cost per factory hour H Reasons for use H Throughput accounting ratio (TPAR) H Decision making 10 www.studyinteractive.org
CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS CHAPTER CONTENTS ABSORPTION COSTING ------------------------------------------------- 12 ABSORPTION COSTING A REMINDER 12 TRADITIONAL OVERHEAD ANALYSIS 12 STEPS USING ABSORPTION COSTING 12 CRITICISMS OF ABSORPTION COSTING: 13 RECENT CHANGES IN MANUFACTURING 13 A REVISED ANALYSIS ABC 14 STEPS USING ABC 14 CONDITIONS UNDER WHICH ABC IS MOST APPROPRIATE 17 BENEFITS AND LIMITATIONS 17 ACTIVITY BASED BUDGETING (ABB) ---------------------------------- 18 THROUGHPUT ACCOUNTING ------------------------------------------- 19 BASICS 19 RATIONALE 19 KEY TERMINOLOGY 19 CONCEPTS UNDERPINNING THROUGHPUT ACCOUNTING 20 FACTORS AFFECTING THE VALUE OF THROUGH ACCOUNTING PUT 20 STEPS IN THROUGHPUT ACCOUNTING 20 LIMITATIONS OF THROUGHPUT ACCOUNTING 21 TARGET COSTING-------------------------------------------------------- 22 TRADITIONAL COSTING SYSTEMS 22 TARGET COSTING STEPS 22 CLOSING A TARGET COST GAP 23 IMPLICATIONS OF USING TARGET COSTING 24 LIFE CYCLE COSTING---------------------------------------------------- 25 COMPARISON OF LIFE CYCLE COSTING AND TRADITIONAL MANAGEMENT ACCOUNTING 25 ENVIRONMENTAL ACCOUNTING --------------------------------------- 28 INTRODUCTION 28 TYPES OF ENVIRONMENTAL COSTS 28 MANAGING ENVIRONMENTAL COSTS 29 ENVIRONMENTAL COSTS STRATEGIES 29 METHODS FOR ACCOUNTING OF ENVIRONMENTAL COSTS 29 www.studyinteractive.org 11
CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS ABSORPTION COSTING Absorption costing a reminder The linking of all production costs to the cost unit to prepare a full cost per unit. Uses 1. Stock Valuation 2. Pricing decisions 3. Budgeting Traditional overhead analysis Overhead Cost Cost cost item Centres Units Steps using absorption costing The steps using absorption costing are: 1 Overhead costs are collected in various cost centres Allocation: Specific overhead costs directly relating to individual cost centres, for example, supervision, indirect materials. Apportionment: General or common overhead costs like rent, heating, electricity are incurred as a whole item by the company and therefore have to be distributed to cost centres on some sharing bases like floor area, machine hours, number of staff etc 2 Overhead absorption is achieved by means of a predetermined Overhead Absorption Rate. a. Overhead Absorption Rate = Budgeted Overheads Budgeted Level of Activity * * Activity levels generally used by examiners are number of units, labour hours or machine hours, which means overheads are charged to units on these bases. Number of Units: Labour Hours: Machine Hours: Single product environment Manual manufacturing operations Mechanical manufacturing operations b. Absorbed overheads = OAR x Actual Activity 12 www.studyinteractive.org
CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS Example 1 2P2D Ltd 2P2D Ltd produces 2 products in 2 departments. Relevant product information is: Product A Product B Direct material cost ( ) 20 35 Direct labour cost in Department X ( ) 20 30 Time per unit in Department X (Hours) 4 6 Direct labour cost in Department Y ( ) 25 35 Time per unit in Department Y (Hours) 5 7 Budgeted number of units 2,000 1,000 The labour rate is 5 per hour in each department. The Budgeted Departmental Overheads are: Department X 18,000 Department Y 6,500 Required: Calculate the cost/unit using: (a) (b) (c) Separate OARs for each department, based on labour hours. An overall OAR, based on labour hours. Discuss the differences. Criticisms of absorption costing Criticisms of absorption costing are: H H H A big amount of guess work in relating overhead costs to the products. Inappropriate bases to link overheads to products Can only work in single product and simple manufacturing environments Recent changes in manufacturing The reason for the increasing inaccuracy of absorption costing is due to two basic issues: 1. Increased production complexity. 2. Increased proportion of overhead costs. Production complexity A wide variety of production processes have become more complex in recent years in a number of ways: 1. Flexible manufacturing systems allow for a number of widely differing products to be produced on the same machinery. Absorbing overhead on a simple volume base is unlikely to reflect the differing overhead costs incurred by each product. www.studyinteractive.org 13
CHAPTER 1 COST ACCOUNTING AND NEW DEVELOPMENTS 2. Fast product development may mean that a number of differing iterations of the same product may be produced in quick order. With such products having differing production volumes again a volume base is unlikely to work. 3. Wider product ranges lead to a more complex cost analysis. Increased proportion of overhead costs Overheads have increased in importance as a percentage of total costs due to both the substitution of direct labour with indirect labour as companies mechanise to a greater degree. Also the increased production complexity outlined above has given rise to increased costs for such disciplines as production planning and logistics. Increased proportion of support services costs Activity based costing also introduces the important aspect that cost are incurred in selling and distributing a product and the cost of servicing customers are often more important than production therefore an accurate cause effect relationship should be established as to what generates the cost and what is the real impact of this cost on the volume of units sold. A revised analysis ABC Overhead Cost Cost Cost Item Pool Unit Steps using ABC The steps involved in ABC are: 1. Identify an organisation s activities. 2. Collect the cost of each activity into what is called cost pool (equivalent to cost centre under traditional costing). 3. Identify the factors which determine the size of the costs of an activity. These are called cost drivers. Activity Ordering Material handling Production scheduling Despatching Possible Cost Drivers number of orders number of production run number of production run number of despatches 4. Assign the cost of activities to products according to the product s demand for activities. Cost Pool is an activity that consumes resources and for which overhead costs are identified and allocated. For each cost pool there should be a cost driver. Cost Driver is any factor which causes a change in the cost of an activity. 14 www.studyinteractive.org
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