CIMA Official Learning System Managerial Level P2 — Performance Management Jo Avis CIMA Publishing is an imprint of Elsevier Linacre House, Jordan Hill, Oxford OX2 8DP, UK 30 Corporate Drive, Suite 400, Burlington, MA 01803, USA First edition 2008 Copyright © 2009 Elsevier Ltd 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 publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone (ϩ44) (0) 1865 843830; fax (ϩ44) (0) 1865 853333; e-mail: permissions@elsevier.com Alternatively you can visit the Science and Technology Books website at www.elsevierdirect.com/rights for further information Notice No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions or ideas contained in the material herein British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data A catalogue record for this book is available from the Library of Congress 978-1-85617-779-5 For information on all CIMA publications visit our website at www.elsevierdirect.com Typeset by Macmillan Publishing Solutions (www.macmillansolutions.com) Printed and bound in Italy 09 10 11 11 10 Working together to grow libraries in developing countries www.elsevier.com | www.bookaid.org | www.sabre.org Contents The CIMA Learning System xi xi xi xii xii xiii xv xvi xxiv Acknowledgements How to use your CIMA Learning System Guide to the Icons used within this Text Guide to Verbs used by the CIMA examiner Study technique Performance Management Syllabus Syllabus overview Transitional arrangements Revision of Basic Aspects, Classifications and Approaches to Cost Accounting 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Learning Outcome Introduction What is meant by cost? Cost units 1.3.1 Composite cost units Cost centres Classification of costs 1.5.1 Classification of costs according to their nature 1.5.2 Classification of costs according to their purpose 1.5.3 Other examples of cost classification Cost behaviour 1.6.1 Fixed cost 1.6.2 Variable cost 1.6.3 Semi-variable cost 1.6.4 Analysing semi-variable costs 1.6.5 Using historical data The elements of cost Summary Absorption Costing, Activity-based Costing and Marginal Costing 2.1 2.2 2.3 2.4 2.5 2.6 Learning Outcome Introduction Overhead allocation and apportionment Overhead absorption Applying the overhead absorption rate Selecting the most appropriate absorption rate Predetermined overhead absorption rates iii 3 4 5 6 7 10 10 13 13 14 15 17 17 17 18 18 19 20 PERFORMANCE MANAGEMENT P2 CONTENTS iv 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.6.1 Under- or over-absorption of overheads 2.6.2 The reasons for under- or over-absorption 2.6.3 Accounting for under- or over-absorbed overheads 2.6.4 The problems caused by under- or over-absorption of overheads Illustrative example Recent developments in absorption costing methods 2.8.1 The criticisms of the traditional approach 2.8.2 Activity-based costing The difference between marginal costing and absorption costing Marginal costing and contribution Preparing profit statements using marginal costing and absorption costing 2.11.1 Profit statements using marginal costing 2.11.2 Profit statements using absorption costing Reconciling the profit figures 2.12.1 Reconciling the profits given by the different methods 2.12.2 Reconciling the profits for different periods 2.12.3 Profit differences in the long term Should marginal costing or absorption costing be used? A comprehensive example of ABC Summary Breakeven Analysis 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 3.11 3.12 3.13 3.14 3.15 Learning Outcomes Introduction Breakeven or cost–volume–profit analysis 3.2.1 Calculating the breakeven point The margin of safety The contribution to sales (C/S) ratio Drawing a basic breakeven chart The contribution breakeven chart The profit–volume chart 3.7.1 The advantage of the profit–volume chart The limitations of breakeven (or CVP) analysis The economist’s breakeven chart Using costs for decision-making 3.10.1 Short-term decision-making Evaluating proposals The impact of risk and uncertainty on cost–volume–profit analysis 3.12.1 Normal distribution and CVP Multi-product CVP analysis Using the C/S ratio – an example Summary Revision Questions Solutions to Revision Questions Relevant Cost and Short-term Decisions 4.1 Learning Outcomes Introduction 20 21 21 22 22 24 24 24 28 28 29 30 30 31 31 32 32 33 33 44 45 47 47 47 47 48 49 50 52 52 53 54 55 55 56 56 58 58 60 62 64 65 69 75 77 77 PERFORMANCE MANAGEMENT Revision Questions Solutions to Revision Questions Linear Programming 5.1 5.2 5.3 5.4 5.5 Learning Outcomes Introduction Basic linear programming 5.2.1 Formulating the mathematical model 5.2.2 The graphical method of solving linear programming models 5.2.3 Further examples of the construction and graphing of constraints 5.2.4 Multiple solutions 5.2.5 Slack and surplus 5.2.6 Shadow prices and opportunity costs The Simplex method 5.3.1 Formulating the problem 5.3.2 Interpreting the solution Worth and relative loss Summary Revision Questions Solutions to Revision Questions Pricing Learning Outcomes 6.1 Introduction 6.2 Demand and the product life cycle 6.2.1 Price elasticity of demand 6.2.2 The product life cycle 6.2.3 The profit-maximisation model 6.2.4 Limitations of the profit-maximisation model 6.3 Pricing strategies based on cost 6.3.1 Total cost-plus pricing 6.3.2 Marginal cost-plus pricing 77 77 79 79 80 80 80 80 80 81 82 82 82 85 87 93 95 103 111 113 113 113 114 115 119 121 123 125 126 126 127 128 130 131 135 141 143 143 143 143 148 150 152 152 152 155 CONTENTS 4.2 Relevant costs 4.2.1 Non-relevant costs 4.3 Opportunity costs 4.3.1 Examples of opportunity costs 4.3.2 Notional costs and opportunity costs 4.4 Avoidable, differential and incremental costs 4.4.1 Avoidable costs 4.4.2 Differential/incremental costs 4.4.3 Using incremental costs 4.4.4 Incremental revenues 4.4.5 Minimum price quotations for special orders 4.5 Limiting factor decision-making 4.5.1 Decisions involving a single limiting factor 4.6 Further decision-making problems 4.6.1 A practical example 4.7 Summary v PERFORMANCE MANAGEMENT P2 6.4 CONTENTS vi 6.5 Other pricing strategies 6.4.1 Premium pricing 6.4.2 Market skimming 6.4.3 Penetration pricing 6.4.4 Price differentiation 6.4.5 Loss leader pricing 6.4.6 Product bundling 6.4.7 Pricing with additional features 6.4.8 Using discounts in pricing 6.4.9 Controlled pricing Summary Revision Questions Solutions to Revision Questions The Value Chain – TQM Learning Outcomes Introduction Continuous improvement Kaizen costing Value analysis Functional analysis The value chain Just-in-time concept Total quality management (TQM) 7.8.1 Quality as a concept 7.8.2 Measuring the cost associated with delivering quality 7.8.3 TQM in practice 7.8.4 Accounting for quality 7.8.5 Criticisms of TQM 7.8.6 Conclusion 7.9 Business process re-engineering 7.10 Gain sharing arrangements 7.11 Summary 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 Revision Questions Solutions to Revision Questions Activity-based Approaches 8.1 8.2 8.3 Learning Outcomes Introduction The overhead problem 8.2.1 Cost behaviour 8.2.2 Absorption costing 8.2.3 Direct product profitability (DPP) Activity-based costing (ABC) 8.3.1 Activity-based costing and activity-based management 8.3.2 Activity-based management: cost management of activities 8.3.3 Costing objects other than products 8.3.4 Activity-based management: customer profitability analysis 156 156 156 157 157 158 158 159 161 161 162 163 167 171 173 173 173 174 174 175 175 176 179 179 180 181 182 182 183 183 183 185 187 189 195 197 197 197 197 198 199 202 202 203 204 205 PERFORMANCE MANAGEMENT 8.5 Revision Questions Solutions to Revision Questions Learning Curves 9.1 9.2 9.3 Learning Outcome Introduction The learning curve 9.2.1 Introduction 9.2.2 The nature of the learning curve 9.2.3 Uses of the learning curve 9.2.4 Deriving the learning rate using logs 9.2.5 Learned behaviour Summary Revision Questions Solutions to Revision Questions 10 Costing Systems Learning Outcomes Introduction Costing systems and manufacturing philosophy 10.2.1 Introduction 10.2.2 Traditional manufacturing philosophy 10.2.3 Modern manufacturing philosophy 10.2.4 Volume versus variety 10.3 Accounting for pull systems – backflush accounting 10.4 Throughput accounting 10.4.1 The theory of constraints (TOC) 10.4.2 Throughput accounting (TA) 10.4.3 Throughput cost control and effectiveness measures 10.4.4 Summary of throughput accounting 10.5 Cost planning and reduction over the life cycle 10.5.1 Target costing: a strategic profit management system 10.5.2 Using target costing in the concept and design stages 10.5.3 Target costing for existing products 10.5.4 Target costing support systems 10.6 Life cycle costing 10.6.1 Life cycle costing – introduction 10.6.2 Product life cycle costing 10.6.3 Customer life cycle costing 10.1 10.2 207 208 209 209 210 210 211 214 215 223 237 239 239 239 239 239 243 244 245 245 247 249 253 255 255 255 255 256 258 258 260 263 263 264 268 269 270 270 272 273 273 275 275 275 278 CONTENTS 8.4 8.3.5 Distribution channel profitability 8.3.6 Activity-based management: strategic activity management 8.3.7 Using ABC in service industries and activities 8.3.8 Problems with implementing ABC Pareto analysis 8.4.1 The rule 8.4.2 Uses of Pareto analysis Summary vii PERFORMANCE MANAGEMENT P2 10.7 CONTENTS viii Summary Revision Questions Solutions to Revision Questions 11 The Principles of Budgeting 11.1 11.2 11.3 11.4 11.5 11.6 Learning Outcomes Introduction The purposes of budgeting 11.2.1 Budgetary planning and control The preparation of budgets 11.3.1 Co-ordination: the budget committee 11.3.2 Participative budgeting 11.3.3 The master budget Sensitivity analysis 11.4.1 Evaluating the consequences of sensitivity analysis 11.4.2 Using spreadsheets in budget preparation Rolling budgets Summary Revision Questions Solutions to Revision Questions 12 Budgetary Control Learning Outcomes 12.1 Introduction 12.2 The Theory of Systems 12.3 System design 12.3.1 The characteristics and components of a system 12.3.2 Control systems 12.4 Feedback control loops and system operation 12.5 Budgetary control information 12.5.1 Budget centres 12.5.2 Budgetary control reports 12.6 Fixed and flexible budgets 12.6.1 Preparing a flexible budget 12.6.2 Using flexible budgets for planning 12.6.3 Flexible budgets 12.6.4 Extrapolating outside the relevant range 12.7 Behavioural aspects of budgetary control 12.7.1 Motivation and co-operation 12.7.2 Failure of goal congruence 12.7.3 The budget as a pot of cash 12.7.4 Budget negotiation 12.7.5 Influence on accounting policies 12.7.6 Budget constrained management styles 12.7.7 Budgets and motivation 12.8 Modern developments in control systems 12.8.1 The problem of discretionary costs 279 281 287 291 293 293 293 293 294 294 294 295 295 295 297 298 300 301 303 305 307 307 308 308 308 308 309 310 310 311 313 313 315 315 317 317 318 318 319 319 320 320 321 321 321 PERFORMANCE MANAGEMENT 12.8.3 12.9 12.8.4 Summary Developments from financial modelling and budgeting packages Rethinking the purpose of the monthly report and decision support systems Beyond budgeting Revision Questions Solutions to Revision Questions 13 Budgeting and Performance Evaluation Learning Outcomes Introduction Performance evaluation 13.2.1 The income statement 13.2.2 Return on capital employed 13.2.3 Asset turnover 13.2.4 Liquidity 13.3 Exercise 13.4 Understanding the business 13.5 Reporting a performance evaluation 13.6 Non-financial performance indicators 13.7 Benchmarking 13.8 The balanced scorecard 13.9 Performance evaluation in the not-for-profit sector 13.10 Summary 13.1 13.2 Revision Questions Solutions to Revision Questions 14 Responsibility Centres and Transfer Pricing 14.1 14.2 14.3 Learning Outcomes Introduction Cost, revenue, profit and investment centres 14.2.1 Cost centres 14.2.2 Profit centres 14.2.3 Revenue centres and investment centres 14.2.4 Reporting responsibility centre results Transfer pricing 14.3.1 Aims and features 14.3.2 General rules 14.3.3 Cost-based prices 14.3.4 Market-based prices 14.3.5 Marginal cost 14.3.6 Dual pricing 14.3.7 Profit-maximising transfer prices 14.3.8 Negotiated transfer prices 14.3.9 Other behavioural considerations 14.3.10 Opportunity cost – the ‘mathematically correct’ transfer price 322 322 323 328 329 335 347 349 349 350 350 351 351 352 352 354 354 355 358 361 362 365 367 369 375 377 377 378 378 379 379 380 382 383 383 384 386 389 390 390 391 392 393 CONTENTS 12.8.2 ix This table shows the Present Value of £1 per annum, Receivable or Payable at the end of each year for n years 1Ϫ (1 ϩ r )Ϫn r Interest rates (r) Periods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 990 1.970 2.941 3.902 4.853 980 1.942 2.884 3.808 4.713 971 1.913 2.829 3.717 4.580 962 1.886 2.775 3.630 4.452 952 1.859 2.723 3.546 4.329 943 1.833 2.673 3.465 4.212 935 1.808 2.624 3.387 4.100 926 1.783 2.577 3.312 3.993 917 1.759 2.531 3.240 3.890 909 1.736 2.487 3.170 3.791 901 1.713 2.444 3.102 3.696 893 1.690 2.402 3.037 3.605 885 1.668 2.361 2.974 3.517 877 1.647 2.322 2.914 3.433 870 1.626 2.283 2.855 3.352 862 1.605 2.246 2.798 3.274 855 1.585 2.210 2.743 3.199 847 1.566 2.174 2.690 3.127 840 1.547 2.140 2.639 3.058 833 1.528 2.106 2.589 2.991 10 5.795 6.728 7.652 8.566 9.471 5.601 6.472 7.325 8.162 8.983 5.417 6.230 7.020 7.786 8.530 5.242 6.002 6.733 7.435 8.111 5.076 5.786 6.463 7.108 7.722 4.917 5.582 6.210 6.802 7.360 4.767 5.389 5.971 6.515 7.024 4.623 5.206 5.747 6.247 6.710 4.486 5.033 5.535 5.995 6.418 4.355 4.868 5.335 5.759 6.145 4.231 4.712 5.146 5.537 5.889 4.111 4.564 4.968 5.328 5.650 3.998 4.423 4.799 5.132 5.426 3.889 4.288 4.639 4.946 5.216 3.784 4.160 4.487 4.772 5.019 3.685 4.039 4.344 4.607 4.833 3.589 3.922 4.207 4.451 4.659 3.498 3.812 4.078 4.303 4.494 3.410 3.706 3.954 4.163 4.339 3.326 3.605 3.837 4.031 4.192 11 12 13 14 15 10.368 11.255 12.134 13.004 13.865 9.787 9.253 8.760 8.306 10.575 9.954 9.385 8.863 11.348 10.635 9.986 9.394 12.106 11.296 10.563 9.899 12.849 11.938 11.118 10.380 7.887 8.384 8.853 9.295 9.712 7.499 7.943 8.358 8.745 9.108 7.139 7.536 9.904 8.244 8.559 6.805 7.161 7.487 7.786 8.061 6.495 6.814 7.103 7.367 7.606 6.207 6.492 6.750 6.982 7.191 5.938 6.194 6.424 6.628 6.811 5.687 5.918 6.122 6.302 6.462 5.453 5.660 5.842 6.002 6.142 5.234 5.421 5.583 5.724 5.847 5.029 5.197 5.342 5.468 5.575 4.836 4.988 5.118 5.229 5.324 4.656 4.793 4.910 5.008 5.092 4.486 4.611 4.715 4.802 4.876 4.327 4.439 4.533 4.611 4.675 16 17 18 19 20 14.718 15.562 16.398 17.226 18.046 13.578 14.292 14.992 15.679 16.351 10.106 9.447 8.851 8.313 10.477 9.763 9.122 8.544 10.828 10.059 9.372 8.756 11.158 10.336 9.604 8.950 11.470 10.594 9.818 9.129 7.824 8.022 8.201 8.365 8.514 7.379 7.549 7.702 7.839 7.963 6.974 7.120 7.250 7.366 7.469 6.604 6.729 6.840 6.938 7.025 6.265 6.373 6.467 6.550 6.623 5.954 6.047 6.128 6.198 6.259 5.668 5.749 5.818 5.877 5.929 5.405 5.475 5.534 5.584 5.628 5.162 5.222 5.273 5.316 5.353 4.938 4.990 5.033 5.070 5.101 4.730 4.775 4.812 4.843 4.870 12.561 13.166 13.754 14.324 14.878 11.652 12.166 12.659 13.134 13.590 10.838 11.274 11.690 12.085 12.462 SOLUTIONS TO REVISION QUESTIONS P2 CUMULATIVE PRESENT VALUE OF £1 548 PREPARING FOR THE EXAMINATION Exam Q & As At the time of publication there are no exam Q & As available for the 2010 syllabus However, the latest specimen exam papers are available on the CIMA website Actual exam Q & As will be available free of charge to CIMA students on the CIMA website from summer 2010 onwards 549 This page intentionally left blank Index This page intentionally left blank Index A ABC see Activity-based costing (ABC) ABM see Activity-based management (ABM) Abnormal costs, Absorption costing: activity-based costing, 24–8, 198–9, 202–10 concepts, 24 example, 26–7 marginal costing, 28 over- or under-absorption, 21, 22, 32 profit reconciliation, 31 recent developments, 24–8 transfer pricing, 384, 385–6 Accounting: backflush accounting, 260–2 policies, 320 quality, 182 Activity cost driver, 25, 204, 205 Activity cost driver rate, 25 Activity cost pools, 28 Activity levels, 356 Activity-based costing (ABC): activity categories, 25–6 benefits, 202 categories, 25–6 definitions, 24–6 discretionary costs, 321 examples, 26–8 historical background, 198–9 Pareto analysis, 210 problems, 209–10 purposes, 203 services, 198 stages, 25, 202 Activity-based management (ABM): benefits, 203 strategic activity management, 208 Administration costs, Advanced Pricing Agreement (APA), 397 Amstrad, 158, 271, 489 AMTs see Automated Manufacturing Technologies (AMTs) Appraisal costs, 180, 192, 193 Arm’s length prices, 396–7 Assets: asset turnover, 351–2 asset value, 403 tangible assets, 402 AT&T, 209 Automated Manufacturing Technologies (AMTs), 175 Avoidable costs, 80 B B & Q, 179 Backflush accounting, 260–2 Balanced scorecard approach, 362, 372–3 Basic price equation, 150–1 Batch level activities, 26, 224 Batch sizes, costs, 189, 256, 284, 489 Behavioural considerations, 392–3 budgetary control, 317–21 return on investment, 403–4 transfer pricing, 392–3 Bellis-Jones, Robin, 208 Benchmarking, 358–61, 364, 373 budgets, 323, 358–61 non-financial performance indicators, 355–8 not-for-profit sector, 364 responsibility centres, 380 understanding business processes, 327, 359 Best practices, 360, 364, 373 Beyond budgeting (BB), 323–6 Beyond Budgeting Round Table (BBRT), 324 553 INDEX 554 PERFORMANCE MANAGEMENT P2 Binding, linear programming, 126–8 Boeing, 240 Bottom-up budgeting, 295 BPR see Business process re-engineering Branding, 211 Breakeven analysis: calculating the breakeven point, 47–8 contribution, 47, 49, 52 contribution to sales ratio, 49–50 cost–volume–profit analysis, 58–60 economist’s breakeven chart, 55 limitations, 54–5 margin of safety, 48 multi-product CVP analysis, 60–2 normal distribution and CVP, 58–60 profit-volume charts, 52–4 proposal evaluation, 56–8 Breakeven charts, 50–1, 54, 68, 72, 73 Britax Wingard, 179 Budget centres, 310–11 Budget committees, 294 Budgetary control, 328 behavioural considerations, 317–21 flexible budgets, 313–17 information, 310–13 systems theory, 308 Budgetary performance: balanced scorecard approach, 362, 372–3 benchmarking, 323, 358 key metrics, 350 non-financial performance indicators, 355–8 not-for-profit sector, 379 reports, 311–13 understanding business processes, 359, 373 Budgetary planning, 293–4 beyond budgeting debate, 323–6 operational budgets, 327 preparations, 294–5 rolling budgets, 298–300 sensitivity analysis, 295–8 Budgetary slack, 319 Budgeting, capital budgeting, 275, 278 Bundling, 158–9 Business process re-engineering, 183 C C/S see Contribution to sales (C/S) ratio CAD see Computer aided design (CAD) CAE see Computer aided engineering (CAE) CAM see Computer aided manufacturing (CAM) Capacity: linear programming, 126–8 proposal evaluation, 56 Capital budgeting, 275, 278 Capital investment, 400 Capital investment appraisals, 512 Cash conversion period (CCP), 352 Cash flow return on investment (CFROI), 405 Cash flows: product life cycles, 181, 288, 494 Caulkin, Simon, 403, 405 CCP see Cash conversion period (CCP) Centralisation, profit centres, 379 Change: breakeven analysis, 47–50 costs, 159 manufacturing philosophy, 255–9 total quality management, 179–83 CIMA Insider, 360 Co-operation, goal congruence, 318 Co-ordination, budget committees, 294 Committed costs, 78 Committees, 182, 275 budgets, 294 Communications, 372, 373, 421 Comparable price method, 397 Comparable uncontrolled prices (CUPS), 397 Competitive advantages, 176 Complementary products, price elasticity, 148 Composite cost units, Computer aided design (CAD), 179, 274 Computer aided engineering (CAE), 274 Computer aided manufacturing (CAM), 179, 256 Computer systems see Information technology (IT) Computeractive magazine, 158 Conformance costs, 192 Constraints: graphical solutions, 139 linear programming, 138 specifying, 115 see also Limiting factors Continuous improvement, 173 Contribution to sales (C/S) ratio, 49–50 Contribution: breakeven analysis, 47, 49, 52 concepts, 28–9, 52 limiting factors, 82, 84, 155 linear programming, 113 marginal costing, 28 PERFORMANCE MANAGEMENT decision-making, 55–6 drivers, 25, 204, 209, 212 economies of scale, 55, 63, 149, 170, 289, 290 elements, 13–14 mark-ups, 152–4 minimisation, 118–19 nature classification, 5–6 non-relevant, 6, 55, 77–8 overhead allocation, 17–18 pricing strategies, 152–6 product variety issues, 258–9 production run costs, 257 purpose classification, relevant, 6, 55, 77–8 semi-variable, 10 short-term decision making, 56 stock holding costs, 257 theory of constraints, 263–4 throughput accounting, 265–6 total quality management, 180–1 variable, 6, 8–10 volumes, 47, 55, 143–4 see also Fixed costs; Marginal costing; Overhead costs Cox, J., 263 Creditworthiness checks, 270, 280 Cross-elasticity of demand, 143–8 Current ratio, liquidity, 353 Customer relationship management (CRM), 361 Customer satisfaction, 356, 362, 371 Customer service, Customer surveys, 357 Customers: activity-based costing, 24–5, 202, 203 life cycle costing, 278–9 Pareto analysis, 211 CVP see Cost–volume–profit (CVP) analysis D Decentralisation, profit centres, 379 Decision-making: absorption costing, 33 breakeven analysis, 47 capital budgeting, 275, 278 information, 13 limiting factors, 82–5 linear programming, 126–8, 264 Pareto analysis, 211–12 short-term, 56, 77–8, 508 total quality management, 179–83 INDEX Control issues: budgets, 307, 309, 310, 311–12 systems, 308–9, 317, 321 Controllable costs, 6, 310 Controlled prices, 161–2 Cooper, Robin, 204 Corporate cultures, 320 Cost accounting: classifications, 5–6 concepts, 3–6 elements of cost, 13–14 fixed costs, 7–8 high–low method, 11–12 scattergraph method, 12–13 semi-variable costs, 10–13 systems, 384 variable costs, Cost behaviour, 7–13 Cost buckets see Cost pools Cost centres, 5, 378 Cost drivers, 24, 25, 28, 36, 204, 209, 212 Cost objects, 24 Cost of Quality Report, 182 Cost pools, 25 Cost units, Cost-based prices, 384–6 Cost-plus method, 397 Cost-plus pricing, 152–4 Cost–volume–profit (CVP) analysis, 47–8 risk and uncertainty impact, 58–60 see also Breakeven analysis Costing systems: absorption costing, 24–6 activity-based costing, 24–6 change, 159 customer life cycle costing, 278–9 just-in-time system, 176 life cycle costing, 275–9 manufacturing philosophy, 255–6 product life cycle costing, 276–9 pull systems, 177–9 standard costing, 274 target costing, 271 see also Marginal costing Costs: activity-based management, 202–3 batch sizes, 189, 256, 284, 489 behaviour, 7–13 changes, 159 classification, 5–6 concepts, 3–6 555 INDEX 556 PERFORMANCE MANAGEMENT P2 Decision variables, linear programming, 115 Demand: elasticities, 143–8, 154 pricing, 143–8 product life cycles, 148–50 Department of the Environment, 364 Depreciation, 78, 98, 355 Design issues: systems theory, 308 Developments: modern economic environments, 323 Differential costs, 80 Differentiated products, 148 Direct costs, attributable fixed costs, 79 labour, 8, 9, 19, 34, 198, 243, 441, 450 materials, 8, 20 wages cost percentage, 20 Direct product profitability (DPP): concepts, 199–201 historical background, 199 Discounts, 161 Discretionary costs, 321–2 Disposable income, price elasticity, 148 Distribution channel profitability, 207 Double taxation agreements, 396 DPP see Direct product profitability (DPP) Drury, 404 Dual pricing, 390 E Economic value added (EVA), 405 Economies of scale, 55, 63, 170, 289, 290 Economists: breakeven chart, 55 profit maximisation issues, 267 Effectiveness measures, throughput accounting, 268–9 Efficiencies, 189, 204, 496 balanced scorecard, 361–2 not-for-profit sector, 363–4 EFTPOS, 201 Elasticities of demand, 143–8 Employee empowerment, 181 Engineered costs, 322 Environments, modern businesses, 362 EPOS, 179, 201 Examinations: format/paper structure, 431 preparation, 429–31 revision questions, 433–74 revision technique, 429–30 solutions to revision questions, 475–548 tips, 418–20 Executive share options, 405 External failure cost, 180, 192 Extra features, pricing, 159–61 F Facility level activities, 26 Feasible region, linear programming, 116, 127 Feedback control systems, 309 Feedforward control systems, 309 Fixed costs: breakeven analysis, 47–52 flexible budgets, 313–17 overhead problem, 197–8 per unit, short-term decision making, 56, 508 throughput accounting, 264 Fixed-overhead absorption rates, 20 Fixed overheads, 78 Flexible budgets, 315–17 Flexible manufacturing systems (FMS), 256 Formats: budgetary control reports, 311 Forward looking performance indicators, 354 Fraser, R., 324, 349 Full capacity, 395 Functional analysis, 175 Funds repatriation, 399 Future costs, 78 G Gain sharing arrangements, 183–5 Galloway, David, 264 Garrett Automotive, 257 General Electric, 403 Goal congruence, 318 failure of, 318–19 Goldratt, Eli, 263, 264 Grocery trade, 199 Gross margin methods, 397 Growth, return on investment, 351, 403–4 Grundig, 271 H Heijunka principle, 179 Hewlett-Packard, 277–8 High–low method, 11–12 Historical cost depreciation, 78 Historical data, semi-variable costs, 10–13 PERFORMANCE MANAGEMENT I Idle time, 443 Income: elasticity of demand, 143–8 price elasticity, 143, 148 Income statement: elements of cost, 351 profitability, 350 reports, 355 revenue, 350 Incremental costs, 80 Incremental revenues, 81 Indirect costs, Inefficiencies, 189, 204 Inflation: breakeven analysis, 47–74 semi-variable costs, 10–13 Information: activity-based costing, 24–5, 202 budgetary control, 310, 311, 312 monthly reports, 322 non-financial information, 359 pricing decisions, 144–8 Information technology (IT): customer relationship management, 361 databases, 322 direct product profitability, 199–201 linear programming, 126–8 Simplex method, 126–8 spreadsheets, 322 Innovations: balanced scorecard, 327, 362 non-financial performance indicators, 357 Inputs/outputs: engineered costs, 322 Inter-industry benchmarking, 359, 373 Internal efficiency, balanced scorecard, 362 Internal failure costs, 180, 192 International intra-group trading, 395 Intra-group benchmarking, 359 Intra-group trading, 395 Intra-group transfers, return on investment, 403 Investment centres, 378, 379, 382, 401, 403 IT see Information technology (IT) J Japan, 173, 174, 228, 229, 257, 270, 274, 396, 400, 489 Joint products, 92 Just-in-time (JIT) system, 176–9 concepts, 176–9 production, 191 purchasing, 177 suppliers, 178 total quality management, 179–83 K Kaizen costing, 174 Kanbans, 178, 190 Kaplan, R, 204, 362 Kato, 270, 274 Kinked demand curve, 147, 148 Knowledge see Information L Labour: absorption costing, 24, 33, 198–9, 202, 228, 252, 508 linear programming, 113–30 Lead times, 178, 269 Learned behaviour, 245 Learning curves: concepts, 239 definition, 239 formula, 242 uses, 243 Ledger accounts, backflush accounting, 260–2 Liability turnover, 351 Life cycle costing: concepts, 275, 494 product life cycle costing, 275–8 Limiting factors, 41 linear programming, 113 short-term decision making, 82–5 Linear programming, 113–30 airline industry, 129 concepts, 113 constraints, 119–21, 138 decision variables, 115 formulation of model, 114–15 graphical solutions, 115–19 limiting factors, 113 manufacturing industry, 130 INDEX Hoffman La Roche, 396 Hope, J., 324, 349 Horizontal analysis, reports, 354 Hospital waiting lists, 364 Human resources: direct labour, 19, 21 target costing, 174, 270 557 INDEX 558 PERFORMANCE MANAGEMENT P2 Linear programming (Continued) multiple solutions, 121–3 non-negativity conditions, 115 nutritionists, 130 opportunity costs, 125–6 relative loss, 128–30 shadow prices, 125–6 Simplex method, 126–8 slack and surplus, 123–4 specifying constraints, 115 throughput accounting, 263–70 worth, 128–30 Linear variable costs, 8, Liquidity, 352 Loss leaders, 158 Losses: transfer pricing, 385 M Machine hour rate, 19, 21, 28 Management: activity-based, 202–10 by walking about, 268 project management, 274 strategic activity, 208 see also Total quality management (TQM) Management Today, 179 Manufacturing: cost hierarchy, 25 lead time, 178, 269 philosophy changes, 258 Margin of safety, 48 Marginal cost-plus pricing, 155–6 Marginal costing, 17–31 absorption costing, 24, 28, 29, 33 contribution, 28–9 historical background, 267 marginal revenues, 150, 163 profit statements, 30 Marginal revenues, 150, 163 Mark-ups, 152–4 Market shares, product life cycles, 181, 255, 288, 494 Market skimming pricing strategies, 156–7 Materials: absorption costing, 198 linear programming, 113–30 Maximised profit issues, 150, 155 Minimum price quotations, 56, 82 Motivation considerations, 295, 318, 321 budgetary control, 310, 311 participative budgeting, 294–5 transfer pricing, 390 Multi-product CVP analysis, 60–2 Multiple solutions, linear programming, 121–3 N Negotiations: budgets, 319–20 transfer pricing, 382–3 Net profit, 350 Network diagrams, theory of constraints, 263–4 Neumann, Bruce, 323 Nissan, 396 Non-controllable costs, Non-financial factors, 56, 88, 89 Non-financial information, 355–7 Non-financial performance indicators (NFPIs), 355–7 Non-linear variable costs, 54 Non-negativity conditions, 115 Non-relevant costs, 6, 77–8 Normal costs, Normal distribution and CVP, 58–60 Norton, 362 Notional costs, 78, 80 O OARs see Overhead absorption rates (OARs) Objective functions, 114 Objective variables, 114 Operating gearing, 63 Operating leverage, 63 Opportunity costs, 393 linear programming, 113–30 short-term decision making, 82–5 Optimum defects level, 182 Organisation for Economic Co-operation and Development (OECD), 396 Over-absorption, 20, 21, 31, 32 Overhead absorption rates (OARs), 20–1 predetermined, 20 Overhead costs, 20 absorption costing, 198–9 activity-based costing, 24–8 allocation, 17–18 apportionment, 17–18 concepts, 17, 18 over- or under-absorption, 201, 494 Pareto analysis, 210 problems, 197–201 short-term decision making, 56, 82–5 PERFORMANCE MANAGEMENT market skimming strategies, 156–7 penetration pricing, 157 premium pricing, 156 price differentiation, 157–8 product life cycles, 148–50, 255, 288 profit maximisation issues, 267 psychological considerations, 146 regulating bodies, 161 skimming strategies, 156 target costing, 174, 270 transfer pricing, 382 Prime cost percentage, 20 Privatisations, 161 Processing time, 178 Product contribution, Pareto analysis, 212 Product costing, 20, 43, 202, 203, 269, 270, 449 Product level activities, 26 Product life cycles, 148–50, 255, 288 cash flow management, 277 concepts, 149 costing, 152 design costs, 277 price elasticity of demand, 157–8 returns maps, 277, 278 target costing, 174, 270 time to market issues, 277 Product-specific fixed costs, 79 Production: absorption costing, 198–9 costs, 43 just-in-time system, 176 lead times, 178 plans, 82, 268 run costs, 43, 257 Productivity, 356 Products: bundling, 158–9 differentiation, 157–8 direct product profitability, 199–201 extra features, 159–61 returns per minute, 265 variety explosion, 257, 259 see also Pricing Profit centres, 379 Profit margins, 350 Profit maximising transfer values, 390 Profit sharing see Gain sharing arrangements Profit statements, costing, 29, 30 Profit-volume (P/V) ratio, 49 INDEX P P/V see Profit-volume (P/V) ratio Padded budgets, 319 Pareto analysis, 210 activity-based costing (ABC), 202 concepts, 210 uses, 211–12 Participative budgeting, 294–5 Past costs, 77 Penetration pricing, 157 Percentage returns, 401–2 Performance indicators, 364, 380 Performance measures: cash flow return on investment, 405 current thinking, 405 economic value added, 405 investment centres, 399–400 residual income, 403–4, 423 return on capital employed, 351, 400, 422 return on investment, 351, 400–1, 403, 405 return on sales, 400 traditional measures, 360 Period costs see Fixed costs Peters, Tom, 356 Planning, 272, 429–30 flexible budgets, 315 Policies, accounting, 320 ‘Pot of cash’ attitudes, 319 Predetermined overhead absorption rates, 20–2 Premium pricing, 156 Prevention costs, 180–1, 192 Price elasticity of demand, 143–8 concepts, 145 influencing factors, 148 product life cycles, 148–50 Price stickiness, 147 Pricing, 152–6 Advanced Pricing Agreement, 397 arm’s length prices, 397 bundling strategies, 158–9 comparable uncontrolled prices, 397 controlled prices, 161–2 cost-plus pricing, 152–4 demand, 157 differentiation, 157–8 discounts, 161 extra features, 159 learning curves, 239–5 loss leaders, 158 mark-ups, 152–4 market-based pricing, 386–7 559 INDEX 560 PERFORMANCE MANAGEMENT P2 Profits: balanced scorecard, 362, 363 concepts, 47 constraints, 47–8 customers, 205 direct product profitability, 199–201 life cycle costing, 275 mark-ups, 152–4 maximisation, 267 net profit, 350 pricing, 152–4, 156 product life cycles, 148–50 reconciliation, 31 strategic issues, 268 target costing, 174, 270 see also Revenues Project management, 274 Proposal evaluation, 56–8 Psychological considerations, price changes, 146 Public sector, 359, 361 Pull system, 176, 177, 178, 260 Purchasing, just-in-time system, 177, 190 Push system, 177 Q Quality issues, 192 absorption costing, 198–9 concept, 179 participative budgeting, 294–5 premium pricing, 156 service quality, 356 see also Total quality management (TQM) R Rate per unit, 19 Ratio, liquidity, 352 Raw and in progress accounts (RIPs), 261 Reconciliation, profits, 31 Rectification costs, 180 Regional division budgets, 311 Regulating bodies, 161 Relative loss, linear programming, 128–30 Relevant costs, 77–9 decision making, 55–6 short-term decision making, 77–93 Repatriation, funds, 399 Reports: monthly reports, 322–3 performance evaluation, 354–5 responsibility centres, 380 Resale price methods, 397 Research and development (R&D): target costing, 493–4 value chain, 175–6 Residual income (RI), 403–4 Resource cost drivers, 24 Resources see Constraints Responsibility centres: budget centres, 310–11 cost centres, 378 investment centres, 379, 399–405 profit centres, 379 revenue centres, 379 Retailers: activity-based costing, 24–8 direct product profitability, 199 Return on capital employed (ROCE), 351, 354, 403, 422, 423 Return on investment (ROI): asset value, 403 behavioural considerations, 392–3 concepts, 400–1 current thinking, 405 intra-group transfers, 403 percentage returns, 401–2 problems, 401–3 return on capital employed, 351 short-term versus long-term returns, 402 Return on sales (ROS), 400 Returns: maps, 277, 278 per time period ratio, 264 product returns per minute, 265 Revenue centres, 379 Revenues, 81 income statement, 350 life cycle costing, 275 marginal revenues, 150, 163, 389 product life cycles, 148–50 short-term decision making, 77–93 see also Profits Revision technique, 429–30 RIPs see Raw and in progress accounts (RIPs) Risk, on cost–volume–profit analysis, 58 ROI see Return on investment (ROI) Rolling budgets, 298–300 Routines, 245, 430 S Sales: volume interactions, 143–4 Sanyo, 204 PERFORMANCE MANAGEMENT Suppliers, just-in-time system, 178, 190 Support systems, target costing, 273–4 Surplus, linear programming, 123–4 Surveys, customers, 357 Svenska Handelsbanken, 326 Systems theory, 308 T TA see Throughput accounting (TA) Tangible assets, 402 Target costing, 174, 270 breakdown, 175, 263 concepts, 270 existing products, 273 planning, 270, 272 support systems, 273–4 systems theory, 309 Taxation, 396–7 Teams, 181 Theory of constraints (TOC), 263–4 Throughput accounting (TA), 263–5 concepts, 263–5 effectiveness measures, 268–9 limiting factors, 265 product costing, 20, 43, 202, 270 Time periods: cash conversion period, 352 Tips, the examination, 418–20 TOC see Theory of constraints (TOC) Total cost-plus pricing, 152–4 Total quality management (TQM), 179–83 costs, 201 criticisms, 182–3 just-in-time system, 176 practice, 181–2 quality concept, 179 value chain, 175–6 Toyota, 177, 257 TQM see Total quality management (TQM) Traditional budgeting: beyond budgeting, 323–6, 358 Transfer pricing: aims, 383 behavioural considerations, 392–3 cost-based prices, 384–6 dual pricing, 390 features, 383 funds repatriation, 399 general rules, 383 marginal costs, 389, 393–4 market-based prices, 386–7 INDEX Scarlett, Bob, 360, 380 Scattergraph method, 12–13 Segmentation, 157 Selling costs, 32, 151 Semi-variable costs, 315 analysis, 10–13 Sensitivity analysis, 295–8 Sequential tracking systems, 260 Services: activity-based costing, 24–8 direct product profitability, 199–201 Shadow prices, 125–6 Share options, 405 Shareholder issues, 399, 418 Short-term decision making, 77–93 accept/reject order decision, 85 closure decision, 89 incremental revenues, 81 limiting factors, 82–5 minimum price quotations, 82 opportunity costs, 79–80 Simplex method, 126–8 Skimming pricing strategies, 156–7 Slack, linear programming, 123–4 South America, 399 Split-off point, 92 Spreadsheets: budget preparations, 297–8 monthly reports, 322–3 sensitivity analysis, 295–8 Staff experience, 357 Standard costing, 190, 270, 272, 273 benchmarking, 358–60 transfer pricing, 382, 392 Stepped fixed costs, 7, Stock: holding costs, 191, 230, 257 just-in-time system, 177 Pareto analysis, 211–14 Strategic activity management, 203, 208 Strategic business units (SBUs), 399–400 see also Investment centres Strategic Finance, 323, 324, 327, 349 Strategic issues, 268 Strict equalities, 116, 120 Subsidiaries, funds repatriation, 399 Subsidies, transfer pricing, 399 Success factors: balanced scorecard, 362 non-financial performance indicators, 356 Sunk costs, 77, 92, 155 561 INDEX 562 PERFORMANCE MANAGEMENT P2 Transfer pricing: (Continued) minority shareholders, 399 negotiations, 391–2 non-financial performance indicators, 355–8 profit-maximisation, 390–1 reports, 354 standard costing, 386, 392 subsidies, 399 taxation, 395–7 Trends: Travel expenses, 87 Turnover, 351–2 Two-part tariff costing system, 384, 386 U Uncertainty: cost–volume–profit analysis, 58 reduction techniques, 270–2 sensitivity analysis, 295–8 Uncontrollable costs, 310, 311, 318, 380 Under-absorption, 21, 22, 32, 494 Uniform costing see Absorption costing Unit level activities, 25 Unit variable costs, 54, 165 United Kingdom (UK): return on investment, 401 transfer pricing, 397 United States of America (USA), 229, 263, 264 return on investment, 401 transfer pricing, 395–7 Updating processes: rolling budgets, 298–300 V Value analysis (VA), 174–5 Value chains, 175–6, 178 Value engineering (VE), 274 Variable costs, 500 discretionary costs, 321 flexible budgets, 313–15 per unit, 8, 56, 165 semi-variable costs, 315 sensitivity analysis, 295–8 short-term decision making, 77–93 transfer pricing, 382 Variances, 494 flexible budgets, 313–14 Variety explosion, products, 257, 259 VE see Value engineering (VE) Vertical analysis, reports, 354–5 Volume interaction: pricing, 152–4, 156 sales, 143–4 variety, cost relationship, 259 W Waldron, David, 264 WCM see World-class manufacturing (WCM) Wealth distribution, 210 Wedgwood, Josiah, 157 World-class manufacturing (WCM), 176 Worth, linear programming, 128–30 Z Zero-based budgeting (ZBB): discretionary costs, 321–2 .. .CIMA Official Learning System Managerial Level P2 — Performance Management Jo Avis CIMA Publishing is an imprint of Elsevier Linacre House, Jordan Hill, Oxford... of ‘beyond budgeting’ techniques PERFORMANCE MANAGEMENT P2 P2 – C Budgeting and Management Control (20%) xxii THE CIMA LEARNING SYSTEM P2 – D Control and Performance Measurement of Responsibility... Centres Study Weighting 30% 30% 20% 20% THE CIMA LEARNING SYSTEM Tips for effective studying xv THE CIMA LEARNING SYSTEM xvi PERFORMANCE MANAGEMENT P2 Syllabus overview The focus of this paper