Professional Documents
Culture Documents
Mahmood Reza
FRSA, MCMI, ATT, FCCA, DMS, PGCE, BSc (Hons)
www.proactiveresolutions.com
Introduction
Exam structure
SYLLABUS SECTION A
14
Benchmarking
14
Budgeting
15
ABC, ABB,
17
BPR
19
SYLLABUS SECTION B
20
20
Pricing
21
Stakeholder analysis
22
23
SYLLABUS SECTION C
25
SYLLABUS SECTION D
27
27
27
28
28
32
32
35
35
Performance measures
o
36
Residual income
37
37
38
38
EPS
39
39
Agency theory
40
SYLLABUS SECTION E
42
42
43
44
44
Balanced scorecard
46
49
ABM
50
SYLLABUS SECTION F
Target costing
51
Performance prism
52
52
55
56
57
59
INTRODUCTION
These ACCA P5 exam support notes are based on my experience, not only in respect of
teaching ACCA P5 but over 30 years of teaching business and management. These
notes are not meant to be a comprehensive overview of the syllabus but focus on
selected parts
The notes are provided to supplement existing texts and focus on areas that, in my
experience, students find more challenging. Any feedback regarding the notes (positive
or negative) would be greatly welcomed.
I have adopted a sectional approach to the notes, i.e. notes are provided by syllabus
section, some sectional notes being greater than others.
ACCA P5, in common with the other option papers does not enjoy significantly high pass
rates. However, people do pass the exam; a structured and focused approach to
studying is highly recommended, as well reading around the subject.
It is worth remembering that are an abundant level of support resources available to
assist you in passing your exams. However, unless you have a photographic memory
you will need to apply conventional techniques to passing your exams, e.g. question
practice, question practice, question practice you get the picture.
These support notes are to aid and assist your study programme and to reflect student
requirements, any suggestions for future improvements are greatly welcomed.
ACCA Qualification
The current ACCA Qualification syllabus was first examined in December 2007; a review
of the pass rates for the option papers is shown below.
Paper Dec 07 Jun 08 Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Jun 11
P4
31
36
36
30
41
34
33
30
P6
P7
28
33
36
33
41
39
37
37
39
39
35
32
44
34
45
31
The ACCA Professional syllabuses were updated with effect from June 2011, these
notes are based on that syllabus and study guide for the June 2011 exam diet.
The strategic planning process was examined in detail in the P3 paper. In P5 the focus
is more on the performance management aspects of strategic planning and the role of
strategic management accounting.
Lists of rote-learned advantages and disadvantages for different approaches will not
produce a complete answer as a candidate will be expected to tailor this knowledge to
the situation given in the question. So for example, Question 2 of December 2010 asked
for an evaluation of two costing systems within a laptop manufacturer. A good answer
considered the advantages and disadvantages of the absorption costing and activitybased costing in a dynamic, competitive, bespoke-manufacturing environment.
Cover the whole syllabus
Remember that, broadly, the exam will test the capabilities listed in the syllabus that are
required of a candidate. There are six capabilities and most will feature to some extent in
every diet:
v Use strategic planning and control models to plan and monitor organisational
performance
v Assess and identify relevant macroeconomic, fiscal and market factors and key
external influences on organisational performance
v Identify and evaluate the design features of effective performance management
information and monitoring systems
v Apply appropriate strategic performance measurement techniques in evaluating
and improving organisational performance
v Advise clients and senior management on strategic business performance
evaluation and on recognising vulnerability to corporate failure
v Identify and assess the impact of current developments in management
accounting and performance management on measuring, evaluating and
improving organisational performance
The paper will aim to address issues at both the strategic and operational levels and will
often require a candidate to understand the connections between these levels. For
example, the question of how strategic objectives flow through critical success factors to
performance indicators as in Question 1 of the December 2010 paper.
Another example of the type of question that arises is how does the choice of
operational performance measures impact on the strategic performance of the
organisation? A phrase that rings true in many situations is Druckers dictum What gets
measured gets done. This phrase succinctly points to the impact that the choice of
performance metrics have on the management activity of the firm.
Now these points should illustrate why it is a misapprehension that the paper is
predominantly about performance measurement, it is a performance management
paper. This error often manifests in a candidates over-concentration on detailed
elements of Section D (strategic performance measurement) of the syllabus. As
indicated above, it is important to remember that the ideas contained in the various
metrics need to be coherently applied to meet the strategic needs of an organisation and
this is where other sections of the syllabus will connect to a question, for example,
Section A on how strategic performance fits with the planning and control structures or
Section B on external drivers of performance.
Create information
The candidate is expected to be able to calculate numbers using the various techniques
of the paper; however, it is more important that the candidate can explain what their
numbers mean and what importance to place on them.
ACCA P5 Exam Support Notes
A valuable management accountant will create information from the detailed data given
in a question. It is often best to begin by considering the big picture (what is the overall
objective); next, break down the data into smaller but meaningful (and manageable)
chunks; finally, discuss the individual lines of the data table and even then, a candidate
should focus on the data that explains the overall picture of emission changes.
A good example of this was Question 4 Part b) of the December 2010 paper.
1. Consider the big picture whether the overall target for emission reduction be met.
2. Break down the data into smaller but meaningful (and manageable) chunks road,
rail and air transport
3. Discuss the individual lines of the data table focusing on the data that explains the
overall picture of emission changes the switch from petrol to diesel powered motor
vehicles is complete in commercial vehicles and has led to large reductions in emissions
but such a change may be more difficult in company cars as employees may resist such
a change.
Note specifically, this will require answers that go beyond repeating, in sentence form,
the data given in (say) a table in that question. There many candidates wasted their time
by limiting their comments to only writing out statements such as Commercial Fleet
Diesel use has fallen from 105.4 to 70.1 or even Commercial Fleet Diesel use has gone
down. First, this is stating the obvious to anyone who read the table but also importantly,
this is far too detailed for most reporting purposes.
Candidates will be expected to analyse not merely calculate numerical data given from a
scenario.
Overall
A candidate would be advised to ask him/herself if the answer they have produced
would help the organisation to answer the question requirement.
Remember try to add value with your answers by way of comments relevant to the
issue at hand.
Article end
ACCA P5 SYLLABUS CHANGES: SUMMARY
Paper P5 syllabus changes for 2011
June 2011 will see an amended syllabus introduced for a number of ACCA papers
including Paper P5, Advanced Performance Management. In this article, I will run
through these changes explaining the rationale behind them and the effect on the Paper
P5 exam. The article begins with an overview of the main changes and concludes with a
detailed discussion of the changes to the study guide.
Overview
The changes to the Paper P5 syllabus are not fundamental. The six learning capabilities
that a candidate must be able to demonstrate are unchanged.
However, there are a number of changes to the syllabus and detailed Study Guide which
are outlined below. Some of the changes were motivated by a requirement to move
some of the strategic management accounting topics out of an optional paper and into
an essential paper; some of the changes arose from a desire to more clearly differentiate
Paper P5 from Paper F5, Performance Management and Paper P3, Business Analysis
and the remainder were made in order to clarify and update the previous syllabus.
The substantive changes are:
Two new areas have been added to the syllabus from Paper P3. They are quality and
human resource management. Questions on these areas will connect to the rest of
syllabus by being focused on their impact on the performance of the organisation and its
performance management systems.
On quality management, the new areas seek to differentiate the different types of activity
involved in quality management and the impact of such initiatives on existing
performance management systems.
For example, a candidate may have to give advice on how quality initiatives require:
v The need for new information of a more subjective or qualitative nature
v Changes to the key performance measures used in the organisation
v The culture and style of management to alter (team working)
v Changes to human resources management (staff training, recruitment, and
empowerment).
The application of quality management practices is not, in itself, new to Paper P5 having
been a current issue for some time and so the extension to cover these other areas is
quite natural.
On human resource management and reward systems, once again the change is an
extension of topics that have already been in the Paper P5 syllabus. The connection
between appraisal and reward systems and the motivation of staff to improve the
performance of an organisation has been present in the syllabus for some time. The
additional elements should be seen as adding greater depth to those points. Appraisal
and reward systems have been a topic of current debate with many commentators
arguing that they were a significant factor in the recent banking crisis driving managers
to take too many risks.
An area of greater emphasis in the syllabus is the need to address risk and uncertainty
in management decision making. This has appeared in articles and past paper questions
such as Question 2 in June 2010. It is not intended to dramatically increase the depth of
coverage of this area. However, in line with ACCAs increased educational focus on risk
management, the topic has been given greater prominence in the Study Guide.
Two traditional topics from Paper P5 have moved to Paper P3. However, it is important
to note that they have not vanished from Paper P5. First, much of the detailed pricingtechnique testing has moved into Paper P3 although in Paper P5, it will remain essential
that candidates can recognise the impact of their suggestions and changes on the
pricing decision as this is a key element of performance management.
Second, certain elements of budgeting and costing will now also appear in Paper P3 as
it is necessary that these are considered in a compulsory paper.
These topics will still have relevance to Paper P5 as can be seen from the coverage in
Section A of the syllabus. The focus of Paper P5 questions in this area will be in
assessing different financial control systems and their appropriateness for different types
of organisation (e.g. profit making and not-for-profit).
Extract end
ACCA P5 Exam Support Notes
EXAMINERS COMMENTS
This provides a useful insight into the general problems that students encounter and
extracts have been reproduced below. The original reports are freely available on
ACCAs website.
that object is the performance of a company then the answer can be expected to be
descriptive but based on numerical measures (such as profit, present value or EVA) but
if that object is a performance system or a costing method or a remuneration package
then a candidate is expected to weigh up the advantages and disadvantages of that
method, say, possibly in comparison to other appropriate ways of doing things. It should
also be noted that weighing up the advantages and disadvantages means more than
simply listing them it requires a final application of judgement as to what is appropriate
in the given scenario.
There was a surprising split in candidates performance between the two sections of the
examination. While it was pleasing to see candidates performing well in both questions
in section A, the general performance in section B was disappointing. A possible
explanation of this is that candidates are question spotting and studying mostly those
methods that are developed from F5 knowledge in preference to the new methods and
techniques that are introduced at P5 (which comprise much of section B at this diet).
This is not a prioritisation of work that the syllabus would indicate or that I would
recommend. It was clear from the answers that some candidates were attempting the
section B questions without an adequate basic knowledge of the topic.
A number of candidates seemed to write answers to the questions that they wished had
been asked rather than the question that had actually been set and sadly, these answers
were mostly irrelevant. Candidates should remember that in order to score marks, their
answers need to be technically correct and relevant to the question asked. Therefore,
reading the requirement carefully is vitally important to improving the chances of
producing a passing answer. Examples of this appeared in this paper at question 3 (b)
where the requirement asked Evaluate the existing performance management system at
APX by applying the building block model which was wrongly interpreted to mean
Evaluate the existing performance of APX responses to this imagined question were
often quite good but sadly, irrelevant and so scored poorly. Also, on question 2 (c),
answers were given to the question as if it was regarding four different stakeholders
rather than four different external stakeholders responses regarding internal
stakeholders such as the trustees were, therefore, ignored in marking.
Some candidates continue to display their answers unprofessionally, with a lack of clear
labelling to indicate which questions or question parts are being attempted. Also, many
candidates would benefit by giving more thought to the presentation of their answers e.g.
with the use of subheadings and numbered points. This would not only improve the
organisation of their answers but would also assist the marker.
It was pleasing to see a large number of candidates providing good answers to every
question they attempted and consequently achieving high marks.
Sadly, the examination revealed a large number of candidates who were either
inadequately prepared for the examination or failed to read the question requirements
carefully. The performance in this diet was poorer compared to previous diets partly to
be due to an inability of some candidates to be flexible in their approach to the
examination. As a final level paper, candidates cannot expect there to be one standard
answer to all questions on a given topic. The examination is intended to make the
candidate apply their knowledge to a given scenario and that scenario will always
present new challenges.
As in previous diets, in general, candidates are demonstrating good skill at description
but are weaker on analysis. This is a lesson that has gone unlearned from previous
diets. An example of this was in Q4 (b) where an analysis of a given table of data was
required. This is a core skill for any commercially valuable accountant much like being
able to read a set of accounts. Therefore, these should be straight-forward marks as this
skill is building on those tested at previous levels in the qualification. It is apparent that
many candidates believe that because the basic application of this skill has been tested
at a lower level, it is thus excluded from later diets. This is wrong!
At the professional level, you can expect skills and knowledge obtained at previous
levels to be tested but now in a more complex and realistic scenario. Candidates should
remember that the examination is intended to be a test of their ability to add value in
their work. They can demonstrate that ability by doing things that those they are
reporting to cannot picking out the nuggets of gold from the pile of dirt. Thus, good
characteristics to develop in the interpretation of questions are the strength of will to
maintain focus on the overall objectives, the keen-sight to identify the driving factors of
performance and the breadth of knowledge to be able to suggest methods of
performance improvement.
Presentation of answers continues to show improvement and more candidates are
obtaining higher professional marks as a result. One area that could still be improved is
the use of subheadings to break up long answers and in particular, making sure that
question sub-parts are all clearly indicated. Candidates should also note that bullet point
answers often do not give sufficient detail to earn good marks.
As usual, the examination presented a challenge in the efficient use of the candidates
time. However, well-prepared candidates found this no issue in providing good, complete
answers to all questions. It was noticeable that those candidates who failed to complete
all of the questions were ones who did not have a clear grasp of the question
requirements and the basic knowledge required. As a result they spent considerable
time writing irrelevant or vague answers that gained few marks.
10
It was pleasing to see a large number of candidates providing good answers to every
question they attempted and consequently achieving high marks.
Sadly, the examination revealed a large number of candidates who were either
inadequately prepared for the examination or failed to read the question requirements
carefully. Nevertheless it was pleasing to observe that the improved overall performance
of previous diets has been maintained, where there have been few candidates scoring
very low marks.
In general, candidates are demonstrating good skill at description but are weaker on
analysis. This is a lesson that has gone unlearned from previous diets. Many answers
often limited themselves to basic comments on trends (e.g. in Q1 (iii) and Q5 and tended
to limit their analysis to this has gone up, this has gone down etc. At the professional
level, comments should be helpfully quantified where possible and the commercial
implications discussed. So prevention costs have increased would be improved to the
prevention costs have risen by (e.g.) 12% and this should yield benefits by improving
production quality and so lowering future rectification costs and improving customer
satisfaction. This shows the ability to create information and interpret it for the business
being analysed.
As a further general suggestion to improve candidates technique, those who use the
scenario to provide illustrations of their general knowledge of a topic score more
efficiently and effectively than book-learned definitions supported by vague business
examples.
11
12
13
14
v
Functional: this is a comparison of performance and procedures between similar
functions, but in different organisations and industries. It is more likely than internal
benchmarking to generate benefits to the specific function, but it is unlikely to give wide
benefits throughout the organisation
v
Competitive: this focuses on direct competitors within the same industry and
with specific comparable business operations, or on indirect competitors in related
industries with complementary business operations. There can be practical difficulties in
achieving this.
v
Generic: this is undertaken with external companies in different industries that
represent the "best-in-class" for particular aspects of the selected business operations.
Organisations then need to specify programmes and actions to close the gap. Having
measured ones actual performance and compared it with some form of target,
benchmarking moves from simple measurement through to performance improvements.
Many organisations forget this stage and therefore miss the real benefit of
benchmarking. It is essential that programmes and actions are implemented and that
ongoing performance is monitored.
Successful and effective benchmarking requires commitment and support from the
board and senior management. Managers need to be as specific as possible when
identifying areas to benchmark. For example, a company that wishes to benchmark
customer service needs to decide what specific aspect of customer service needs to be
examined.
Customer service encompasses a diverse range of activities, such as
dealing with enquiries, handling disappointed customers, issuing refunds and taking
payments. Each of these activities is different, each with its own thought processes,
techniques and controls.
Once the best practices have been identified, the benchmarking team collects the data,
analyses it, and then plots their performance against best practice to help identify
improvement opportunities.
Finally the team decides what is needed to adapt the best practices to suit their own
particular circumstances, this will a re-evaluation and re-design of existing procedures
and approaches. A cost-benefit exercise will usually be carried out and an
implementation timetable with priorities is established.
BUDGETING
Budgets have multiple functions, namely
Planning
v Management produce detailed plans for implementation
Coordination
v Actions of different parts of organisation are brought together
Communication
v Everyone is informed of the plans and policies; top management communicates
to lower level management
Motivation
v This influences managerial behaviour, individuals motivated to perform in line
with objectives. This can encourage inefficiency and conflict between managers
Control
v Assists managers in controlling activities with managements attention
concentrated on deviations from a pre-set plan
ACCA P5 Exam Support Notes
15
Performance Evaluation
v Measuring success of achieving the budget, rewards like bonuses are given in
some companies and is meant to iinfluence human behaviour
Incremental budgeting
Indirect cost and support activities are prepared incrementally, say 5% on last year.
Zero based budgeting
Activities are justified & prioritised before decisions are taken. The approach is that
budgeted expenditure starts from base zero and description of each activity is included
in a decision package, they are evaluated, ranked and resources allocated.
The benefits are that the deficiencies of traditional budgeting are avoided, resources are
allocated by need or benefit; a questioning attitude is created and the focus is on
attention on outputs in relation to value for money
Anthony (1965) categorised control into three main types:
Strategic Control
v The setting of corporate strategy and long term objectives for the organisation.
Operational Control
v Operational control is ensuring that specific tasks are carried out. This is primarily
concerned with the processing of inputs and raw materials to get outputs.
Management Control
v Management control is the coordination of the day to day activities in an
organisation to ensure that inputs and raw materials are used efficiently and
effectively towards achieving long term goals. Management control, therefore,
links strategic control and operational control.
Management control utilises regular feedback reporting systems so that corrective action
can taken where variances from plan are identified. The budget plays an important role
here in providing controls to aid management control.
The systematic comparison of planned inputs to actual results made using the budget,
followed by corrective action where deviations from plan exist, is known as a control
system. The system providing the reports for this control system is known as
responsibility accounting. This will be discussed in more detail later in the session.
Feedback and Feed-forward Controls
v Feedback control - occurs where actual outputs are monitored against desired
outputs and corrective action is taken where there is a variance between the two.
v Feed-forward control predictions are made about future outputs and
compared to desired outputs and action is taken where there is a difference
between the two.
So, with feed-forward controls any likely errors can be foreseen and actions taken to
avoid them, whereas, with feedback control actual errors against the plan are identified
and corrective actions taken to achieve the remainder of the plan.
16
17
with each department having its role to play in a cost budget, the departments often
allow budgetary targets to dominate. Their contribution to meeting business and
customer needs is neglected.
2. Conventional cost management fails to recognise that corporate success depends
on the effectiveness of its key business processes. Such processes frequently cross
departmental boundaries. Inadequacies, in any department which contributes to a
business process, can affect the entire organisation which is only as strong as the
weakest link. Traditional management accounting and financial control systems
reflect the needs for a hierarchical function in the organising structure. They do not
recognise or support the effectiveness of the key business processes.
Customer Profitability
The needs of customers can vary radically. In their efforts to retain existing customers
and attract new ones, companies can be drawn into providing widely different levels of
service in respect of many different service elements such as frequency of delivery,
number of order lines, quantity per order line, customer location, discounts given,
salesmen's visits and special orders.
These have one thing in common, they all have associated costs. Conventional cost
accounting techniques rarely recognise them. As a result companies do not know the
true cost of trading with these customers, or even with customer groups. Certain
customers may attract so much cost that they provide no profit contribution at all. In
addition, companies may be unaware of the true value their customers place on the level
of service they provide. Under such circumstances, companies may be trading at a loss
with certain customers, giving them a costly service which they do not actually require.
ABC is one answer in view of the drawbacks of conventional cost management.
The ABC approach recognises the following v The need to generate product costs that more accurately reflect the factors
which drive them, such as variety and complexity - not just volume.
v The requirement to attribute the cost of differing levels of service to your
customers in order to establish true customer profitability.
v The need to be able to measure the cost of failure throughout the
organisation, particularly in the overhead functions, so as to focus
management attention to the major opportunities for improvement.
v The need to identify the factors that drive costs and helps guide managers as
to where they can best direct their efforts in order to control costs.
v The crucial importance of the key business processes.
ABB
The idea behind activity based budgeting is to develop an activity model (or series of
linked cost centre activity models) of resource requirements. This model can then be
flexed to affect different volume assumptions which may need to be evaluated after the
first stage of the budgeting process (external assessment). It can also be used as a
basis for identifying and producing performance improvement. Once the final budget
model has been agreed, it then forms the basis for management control through
variance analysis with a more complete understanding of the impact of changing
volumes on activity resource requirements.
ACCA P5 Exam Support Notes
18
19
20
He can buy quantities of 50, 100, 150 or 200 kg at a price of 4 per 10 kg. The selling
price is 1 per kg with any unsold apples being scrapped.
Required
a)
b)
c)
PRICING
There are three general approaches to pricing
Market based approach, which includes
v Target pricing
v Market skimming
v Price differentiation
v Competitive pricing
Cost based
v Cost plus
Economic approach
v MR = MC
MARKET-BASED PRICING STRATEGIES
The actual approach to be adopted will be influenced by the stage in the product life
cycle and general market considerations such as
Companys Market Position
v The nature of the market & its share
v Whether the company is price setter or price taker
v The likely competitor reaction
The Macro-Economic Status
v Is the economy experiencing boom, recession or confidence?
Other Aspects of the Marketing Mix
v The product mix
v Any constraints of range
v Are there bundling opportunities
v Place
v Promotion
v Product / service attributes
COST STRATEGIES
Marginal-Cost
v Unit Selling Price = Variable Cost + % contribution
v Normally used for short-run tactical or scarce resource situations
ACCA P5 Exam Support Notes
21
22
Stakeholder power
Low
High
Low
High
A. Minimal effort;
Probability of exercising
power/level of interest
B. Keep informed;
C. Keep satisfied;
D. Key players.
Economic
Substitutes
Suppliers
Customers
Your
Organisation
Political
Social
Entrants
Stakeholders
Competitors
Macro
Environment
Technological
Competitive
Environment
23
A mere listing of PESTEL influences has little value, it is important to identify the key
opportunities and threats facing the company (a) at present, (b) in the future and how
these are, in effect drivers for change. A PESTEL analysis should also examine the
differential impact of these macro environmental influences by asking how they affect
different companies differently. Some form of impact analysis and scenario planning is
especially useful to explore different possible futures. This exercise allows what if
questions to be explored.
SWOT
This is a strategic planning tool which summarises the key issues from the business
environment and the strategic capability of an organisation most likely to impact on
strategy development. This can be used as a basis against which to generate strategic
options and assess future courses of action.
v
v
v
v
The primary aim is to identify the extent to which the current strengths and weaknesses
are relevant to and capable of dealing with the changes taking place in the business
environment. If the strategic capability of an organisation is to be understood the SWOT
analysis is only considered useful if it is comparative, and not absolute to its
competitors or other organisations, i.e. examining strengths, weaknesses, opportunities
and threats relative to competitors.
A SWOT analysis should help focus discussion on future choices and the extent to
which an organisation is capable of supporting these strategies. An effective SWOT
should be limited to four to five factors, focus on major and not marginal areas, be open
and honest and have a priority and emphasis.
24
25
26
27
Vision
VALUES
Mission
Rewards
DIVISIONALISATION
As a business expands it eventually reaches the stage where it becomes appropriate to
split it up into smaller, more manageable units to decentralise. Reasons may include:
v Size a large organisation with centralised management become unpractical
v Nature of work specialists become necessary to deal with the diverse and
complex activities of a business
v Motivation managers need incentives to perform well
v Uncertainty volatile market conditions are better coped with by a manager with
a smaller, closer, sphere of influence
v Geographical it is important to get close to markets and sources of supply
v Fiscal profits can, subject to legal restrictions, be diverted in such a way as to
minimise tax liabilities
It may well be the case that some degree of decentralisation arises as a result of the
way in which a business expands. If the expansion is by take-over of companies that
then become subsidiaries within group, a decentralised structure automatically arises.
One condition for a successful decentralisation is that the various divisions should be
more or less interdependent of each other. However, in practice, this is unlikely to be
the case and a certain amount of inter-divisional trading will take place. A transfer
pricing policy is needed if goods and services are passed between divisions.
Two of the main organisational structures are functional or divisionalised, represented as
follows:
28
FUNCTIONAL STRUCTURE
DIVISIONAL STRUCTURE
TRANSFER PRICING
Transfer pricing deals with the problem of pricing products or services sold (Transferred
within an organisation). Decisions over suitable transfer prices are needed if a firm has
split itself into autonomous units i.e. it has decentralised or is involved in setting prices
between connected companies in different countries.
The approaches to setting transfer prices are similar to those for external sales, there
are cost-based methods and market based methods. At first sight it would seem that
setting prices for internal transfers is less critical than for external sales; however it has
to be appreciated that the divisions into which a large group will split itself expect to act
as self-contained units. The decision over transfer pricing is even more critical since top
management is in a position to identify whether it is more economical for a product or
29
service to be bought and sold internally or externally, but at the same time needs to take
into account behavioural considerations such as the motivation of divisional managers.
It might appear that the credit to the supplying division is merely offset by an equal debit
to the receiving division and that therefore, as far as the whole organisation is
concerned, it has a net zero effect. This is true in terms of the physical application of a
transfer pricing system once it has been decided upon and implemented. However,
there are important behavioural and organisational elements associated with transfer
pricing and the choice of which method to adopt. The transfer price does affect the profit
of each division separately and, therefore, can affect the level of motivation of each
divisional manager.
Adopting a transfer pricing policy will result in:
Total corporate profit to be divided up between divisional profit centres, it may result
in a cost centre being converted into a profit centre
Information becoming available for divisional decision-making
Information being made available to help assess the performance of divisions and
divisional managers
The rules for the operation of a transfer pricing policy are the same for any policy in a
decentralised organisation. A system should be reasonably easy to operate and
understand as well as being flexible in terms of a changing organisational structure. In
addition there are four specific criteria which a good transfer pricing policy should meet:
It should provide motivation for divisional managers
It should allow divisional autonomy and independence to be maintained
It should allow divisional performance to be assessed objectively
It should ensure that divisional managers make decisions that are in the best
interests of the divisions and also of the company as a whole.(goal congruence)
Setting the transfer price
In the majority of cases the transfer price will be set somewhere between these two
extremes. It is important that the criteria used to pick a price are easy to understand and
that the impact of the price on the profits of the two segments can be easily evaluated.
The difference between the upper and lower prices represents the corporate
profit/savings generated by producing the product or service internally. The chosen price
divides the profit between the two segments. For external reporting this is irrelevant
since the profit element will be eliminated when the financial statements are
consolidated. However this division of profits may be extremely important for internal
reporting since it affects the results of the responsibility reports and hence the success
or failure of the segment.
There are three main methods used to set the transfer price.
Cost-Based Transfer Prices
The big problem with cost-based prices is deciding on the cost to be used. Is it to be an
actual or standard cost? Will it be fully absorbed cost or variable cost and if so what will
be included? Will there be additional elements to cover general and administrative costs
for example?
30
If actual costs are used then the cost may vary according to the season or according to
the efficiency of the supplying segment and the receiving segment will have no idea how
to set its sales prices. What additional costs are included and are they reasonable or
have they been inflated?
Market-Based Cost
Market pricing is believed to be an objective arms length method of arriving at a transfer
price. If a supplying segment is operating efficiently it should be able to make a profit at
this price. Similarly if the receiving segment is operating efficiently it should be able to
make a profit since it would have to purchase at this price if the item was not
manufactured internally.
However several problems may exist in practice. First market price may not be
appropriate because internal production should lead to savings in bad debt, delivery and
marketing expenses. The product or service may not be available on the open market. If
the market price is temporarily depressed or increased due to events beyond the control
of either segment which price should be taken, the normal or the temporary? Finally, in a
market, discounts on price are ordinarily given when volume orders are placed or longterm contracts are signed. Finally the market price may not equal the LRMC and in this
case the company will fail to set it price/output decisions correctly, although this is less
true of commodity products.
Negotiated Transfer Prices
Some companies allow business segments to negotiate the transfer price, usually
between the upper and lower limits set out above. There is an implication here that the
buying segment has the right to purchase form external sources if it cannot agree a
price. Such freedom runs the risk of sub optimisation as segment managers fight to
gain the lions share of the available profit. For this reason the company may specify
arbitration processes and for performance management purposes may evaluate
managers on the basis of the total profit made by both segments, irrespective of the
segment n which they work.
Dual Pricing
To overcome these problems companies can adopt the practice of dual pricing. Here the
agreed transfer price is used only for the purposes of financial reporting of individual
segment results. For management evaluation purposes the variable or absorbed cost is
applied to the results of one or both segments. The difference between the entity and
management price is called the mark-up.
The mark-up is accounted for by assigning it to a different account that is used for
reconciliation purposes. That is to say the amount of mark-up in the buying segments
accounts must equal the amount of mark-up in the selling segments accounts. This
reconciliation is the same as is done for the purposes of consolidation of the accounts.
Using dual pricing allows a company to get the best of both worlds. The transfer price
can be set to meet the regulatory and corporate finance constraints while the price used
by local management can be based on a close approach to the economists long-run
marginal costs so allowing the companys global operations to optimize their third-party
pricing and output decisions on a decentralized management basis.
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32
Threat of
Potential
Entrants
Competitve
Rivalry
Bargaining
Power of
Suppliers
Bargaining
Power of
Buyers
(customers)
Your
Organisation
(Supply conditions)
(Demand conditions
across total
market / segments)
Threat of
Substitutes
Buyer Power
Buyer power is the ability of the buyer to determine the price at which they will buy
irrespective of the decisions of the firm.
v A group of buyers is powerful if for example a buyer purchases large amounts
relative to the sellers total sales.
v If the product bought represents a significant portion of the buyers total
purchases the buyer will tend to shop around for lower prices.
v If the products are standard and undifferentiated the buyer will have more power
over prices.
v If the buyer has few switching costs it will not be locked into a particular seller.
v If the buyer has low profitability it will have to press for low prices.
v If the product is unimportant to the quality of the buyers products or services.
v If the buyer can exercise significant power over which products its customers
purchase as in large retail stores.
Substitute Products
Firms in one industry are also competing with firms in another that produce substitute
products. Substitutes limit returns in an industry by setting a ceiling on the prices the
industry can charge. The more attractive the price-performance of alternatives the firmer
the lid is on industry pricing.
33
Substitute products that need to be closely watched are those with improving priceperformance ratios where the industry that produces them is more profitable than yours.
Supplier Power
Profitable suppliers can squeeze profitability out of an industry if that industry cannot
recoup the cost of higher priced supplies in prices of its own products. The conditions
making suppliers powerful are:
v
v
v
v
v
Rivalry
Rivalry takes the form of price competition, advertising battles, product introductions,
increased customer service, improvements to warranties and so on. Price competition
can leave the whole industry worse off while advertising battles may increase demand
and hence wealth of firms. Intense rivalry is the result of a number of factors:
v Numerous or equally balanced competitors.
v Slow industry growth
v High fixed or storage costs. The significant cost here is fixed cost relative to
value-added.
v Lack of differentiation or switching costs.
v Capacity augmented in large increments
v Diverse competitors
v High strategic stakes
v High barriers to exit. Exit barriers can be economic, strategic and emotional.
They consist of specialised assets, fixed costs of exit, strategic interrelationships,
identification with the business, loyalty to the workforce, fear for ones own
career, government denial or discouragement of exit and so on.
Threats of Entry
New entrants to an industry bring new capacity, the need to gain market share and they
can bring substantial resources. The threat of entry depends on the strength of the
barriers to entry:
v Economies of scale. If these are large then the new entrant has to come in on a
large scale. However these economies of scale must be real. If they are not, as
Xerox discovered when Japanese entrants started following the expiry of patents,
the new entrant may enter at a lower price than the incumbents are
manufacturing for. Scale economies can vary by function, such as selling, or by
operation. For example there are large economies of scale in manufacturing
television colour tubes but not in cabinet making or assembly.
v Product differentiation leads to brand identities and customer loyalties.
v Capital requirements
v Switching costs.
v Access to distribution channels which may be difficult if they are controlled by the
industry.
v Cost disadvantages to the entrant, not brought about by scale, as a result of
proprietary technology, favourable access to materials, favourable locations,
experience curve effects
ACCA P5 Exam Support Notes
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v Expected retaliations
v The entrant will have costs of entry and if the industry price is insufficient to allow
him to recoup these - on other words it is below the Entry Deterring Price - he
will not enter. Where however the industry price is significantly above these then
new entrants will tend to bring the price down to it.
PRODUCT PORTFOLIOS
Because of the inevitability of the eventual decline of all products and services,
businesses seek to reduce their exposure to the risk of a product decline by maintaining
a portfolio of products.
A balanced portfolio will contain products at various stages of the product life cycle.
Conglomerates will seek to minimise the risks found in individual industries by holding
investments in a range of industries.
There are various tools and techniques for analysing a product or Business Unit
investment, portfolio. The most widely used of these is the Boston Consulting Group
Matrix, often referred to either as the Boston Box or the BCG Matrix. This framework
allows the product portfolio to be identified in terms of market share and market growth.
Products/ services are placed in the matrix and identified as question marks, stars, cash
cows and dogs.
BCG MATRIX
High
Stars
Question
Marks
Cash Cows
Dogs
Market
Growth
Low
High
Low
Market Share
(Relative to biggest competitor)
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Existing Marke ts
Existing Products
New Products
Market
Pen etration
Exisiting
customer
strategy
New Markets
Existing prod uct
led strategy
Diversificatio n
A market penetration strategy is one where the company strategy is to increase its
market share in an existing market with current products. This is particularly successful
at developing super-profits when the market is growing strongly. The key strategic
information required is that on the market, its volumes and prices, by customer segment.
A market development strategy is one where the company seeks to increase its
profitability by selling its existing products to new customers (markets) it has never sold
in before. This is most successful when it is based on the most profitable existing
products. The strategic information required here is the direct profit contribution by unit
and an investment strategy based on incremental/opportunity costing based on future
outcomes.
A product development strategy is based on selling new products to existing customers.
Clearly the strategy is most successful when the customers who are approached are
those that are the most profitable to the firm. This will require a soundly based customer
profitability information system.
The diversification strategy requires the company to sell new products to new
customers. Here the management accounting system must be able to clearly identify the
competitive advantage by which the company is going to create its super-profit. Sadly
the evidence is that this is not only the most risky strategy but also one which is
frequently fails.
PERFORMANCE MEASURES
RETURN ON INVESTMENT (ROI)
ROI is similar to the ROCE concept; it is the use and application of the measure that is
different to ROCE. ROI is more commonly applied at the project or SBU (Strategic
Business Unit) level.
Advantages and Disadvantages
The main advantages are that
v Calculations are very simple
v The entire life of the project is taken into account
v Profit is a well understood concept and easily obtainable
v As a relative measure ROI enables comparison against projects or SBUs of
varying sizes
36
37
profits are described as NOPAT (Net Operating Profits after Tax), this being a proxy
measure for net cash flows.
NOPAT is arrived at by making a number of adjustments to accounting profit, example
adjustments being for amortised goodwill, non-cash expenses, provisions and interest
charges.
The economic capital is arrived at by making a number of adjustments to the accounting
measure of capital, example adjustments being for amortised development costs and
goodwill, provisions for doubtful debts.
The financing costs represent the target WACC applied to the economic capital
38
39
Required:
a. Prepare a table for each year of the project showing
v EBITDA
v Net profit
v Residual income using straight line depreciation
v Return on investment using straight line depreciation
v Residual income using annuity depreciation
v Return on investment annuity depreciation
b. Calculate the projects Net Present Value (NPV) and Internal Rate of Return
(IRR)
Human resource management (HRM) refers to the 'strategic and coherent approach to
the management of an organisation's most valued assets: the people working there who
individually and collectively contribute to the achievement of its objectives for sustainable
competitive advantage' (Armstrong).
People are of central importance in most organisations and their recruitment,
management and motivation forms part of the human resource management function.
The definition mentions competitive advantage and this reinforces the link between HRM
and strategy.
HRM goals
If HR strategies are to be effective and successful then HRM must be effective across
four main areas, namely
Commitment: requires good motivation and leadership.
Competence: requires good recruitment, assessment, training and staff development.
Congruence: requires good job design.
Cost-effectiveness: this normally comes from the achievement of the others.
Theories of HRM
The two theories that may be examined are :
v Vrooms expectancy theory; and
v Agency theory
VROOMS EXPECTANCY THEORY
Vrooms theory deals with management and motivation. It assumes that behaviour is
caused by a making a conscious choice from a number of alternatives, pleasure being
maximised and pain minimised. Vrooms realisation was that an employees
performance is based on individual factors such as skills, knowledge, personality,
experience and abilities.
ACCA P5 Exam Support Notes
40
In essence the theory says individuals have differing goals, and they can be motivated if
they have certain expectations.
The expectations arising from expectancy theory are that
v Efforts and performance are positively correlated
v Positive performance results in positive rewards
v Then rewards satisfy an important need
v Desire to satisfy outweighs the effort needed to succeed
The foundation of expectancy theory is based on three main beliefs
Valence: This refers to the emotional orientations that people have regarding
rewards/outcomes, management need to discover what people (employees) value;
Expectancy: Employees do not share the same levels of expectations and they have
differing levels of confidence in their own abilities. Management needs to identify and
provide employees with resources, training and support.
Instrumentality: There is a difference between employees perception of what they
actually desire and what they actually receive by way of rewards. Management need to
ensure that promises are honoured and the fulfilment by management of these promises
is effectively communicated.
The link between the three beliefs can be stated as:
Motivation = Valence expectancy
Agency Theory: Agency theory suggests that an organisation can be seen as
agreements between resource holders. An agency relationship arises whenever one or
more individuals, called principals, hire one or more other individuals, called agents, to
perform some service and then delegate decision-making authority to the agents.
Two of the primary agency relationships in a commercial organisation are between (1
shareholders and managers and (2) between employers and employees. These
relationships are not necessarily positive; and agency theory deals with these agency
conflicts, or conflicts of interest between agents and principals.
This has implications for, among other things, corporate governance and business
ethics. When agency exists, agency costs are also incurred, for example offering
management performance rewards to encourage managers to act in the best interest of
shareholders'.
41
In attempting to establish a clear link between performance and strategy it is vital that
management ensures that the performance measures target areas within the business
where success is a critical factor. The criteria for selecting performance measures for the
scorecard are
ESTABLISHING A PERFORMANCE MANAGEMENT SYSTEM
The start point is usually an organisations underlying mission, vision and strategic
direction, in general the approach
1
2
3
4
5
6
The above can be seen as a cascading effect, i.e. CSFs determine KPIs, we then set a
target and then consider ways to achieve the target KPI; the KPIs are then calculated,
monitored and reported to the board and operational managers. If the target KPIs are
not being met then appropriate action can be taken.
Some sense of prioritisation has to occur otherwise we will merely end up calculating
and monitoring a list of KPIs that have no cohesive linkage and can cause us to lose
sight of our main strategic purpose. This methodology, if developed and implemented
effectively replaces the conventional budgetary reporting system where the focus is
more on cost control important but not the sole determinant of achieving our ultimate
mission.
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Source of data
Frequency
Data entry
Reporting/notifications
Audience/access
Reporting frequency
Reporting formats
Notifications/workflows
Expiry/revision date
Cost estimate
Confidence level
43
44
Within the pyramid the corporate vision is articulated by those responsible for the
strategic direction of the organisation. The pyramid views a range of objectives for both
external effectiveness and internal efficiency. These objectives can be achieved through
measures at various levels as shown in the pyramid. These measures are seen to
interact with each other both horizontally at each level, and vertically across the levels in
the pyramid.
At the bottom level of the pyramid is what Lynch and Cross refer to as 'measuring in the
trenches'. Here the objective is to enhance quality and delivery performance and reduce
cycle time and waste. At this level a number of non-financial indicators will be used in
order to measure the operations. The four levels of the pyramid are seen to fit into each
other in the achievement of objectives. For example, reductions in cycle time and/or
waste will increase productivity and hence profitability and cash flow
The strength of the performance pyramid model lies in the fact that it ties together the
hierarchical view of business performance measurement with the business process
review. It also makes explicit the difference between measures that are of interest to
external parties - such as customer satisfaction, quality and delivery - and measures that
are of interest within the business such as productivity, cycle time and waste.
Lynch and Cross concluded that it was essential that the performance measurement
systems adopted by an organisation should fulfil the following functions:
1. The measures chosen should link operations to strategic goals. It is vital that
departments are aware of the extent to which they are contributing - separately
and together - in achieving strategic aims.
2. The measures chosen must make use of both financial and non-financial
information in such a manner that is of value to departmental managers. In
addition, the availability of the correct information as and when required is
necessary to support decision-making at all levels within an organisation.
3. The real value of the system lies in its ability to focus all business activities on the
requirements of its customers.
These conclusions helped to shape the performance pyramid which can be regarded as
a modeling tool that assists in the design of new performance measurement systems, or
alternatively the re-engineering of such systems that are already in operation.
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BALANCED SCORECARD
The Balanced Scorecard was developed by Kaplan and Norton as an attempt to counter
a rather narrow-minded approach to performance management that relied too heavily on
financial measures. The Balanced Scorecard approach relies on the organisation
defining key dimensions of performance for which discreet yet linked measures can be
reported. The following categories, or perspectives, are measured:
Customers
Internal Process
Learning and growth
Financial
Objectives
Measures
Targets
Initiatives
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Mission
Customer
How do customers see
us?
Financial
Internal Processes
Vision and
Strategy
Which business
processes must we
excel at?
Innovation &
Learning
How do we enable
ourselves to improve,
grow & create value?
Customer Perspective
Two key questions need to be asked here:
Who are our target customers?
What is our value proposition in serving them?
Example measures could include
v Specifications (customer driven): Product quality (restaurant) & service quality
v Service: Responsiveness & customer satisfaction surveys
v Market share: Product/service mix & Innovations and competency
Internal Process Perspective
What are the key processes which we must excel at in order to continue to add value for
customers? Service development and delivery, partnering with the community, and
reporting are examples that could be used.
Learning and Growth Perspective
There will normally be a gap between current organisational infrastructure of employee
skills, information systems, and organisational culture and the level necessary to achieve
the results that are desired.
ACCA P5 Exam Support Notes
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The measures that are used and designed in this perspective will help close the gap.
Employee skills, employee satisfaction, education training, internal rewards and
recognition are examples of such measures.
Financial Perspective
The measures in this perspective tell us whether our strategy execution and
implementation, detailed through measures in the other perspectives, leads to improved
bottom-line results. Typical examples include shareholder value increase, gearing.
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Customer
Service &
Satisfaction
(Looking from
the outside in)
Internal
Operating
Efficiency
(Looking from
the inside out)
Learning and
Growth
(Looking
ahead)
% of earned
income
Income growth
Operating
surplus
Cash balances
Reserves
Patient census
Unit
profitability
funds raised
for capital
improvements
Cost per care
Percent of
revenue new
programmes
Customer
Satisfaction
Customer
retention
Quality customer
service
Income from new
products/services
Patient
Satisfaction
survey
Patient
retention
Patient referral
rate
Admittance of
discharge
timeliness
Medical plan
awareness
Weekly patient
complaints
Patient loads
Breakthroughs
in treatments
and medicines
Infection rates
Readmission
rate
Length of stay
Delivery time
Cost
Process quality
Error rates on
processes
Supplier
Satisfaction
Employee Skill
level
Training
availability
Employee
satisfaction
Job retention
Amount of
unpaid overtime
worked
Training hours
per caregiver
Number if peer
reviewed
papers
published
Employee
turnover rate
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Revenue/cost
per available
passenger
mile
Mix of freight
Mix of full fare
To discounted
Average age
of fleet
Available seat
miles and
related yields
Lost bag
reports
per 10 000
passengers
Denied
boarding rate
Flight
cancellation
rate Customer
complaints
filed with the
DOT
Load factors
(percentage of
seats
occupied)
Utilisation
factors on
aircraft and
personnel
On-time
performance
Employee
absenteeism
Worker safety
statistics
Performance
appraisals
completed
Training
programmes
hours per
employee
Outstanding
loan balances
Deposit
balances
Non- interest
income
Customer
retention
Number of
new
Customers
Number of
products per
customer
Face time
spent between
loan officers
and customers
Sales calls to
potential
customers
Thank You
calls or cards
to new and
existing
customers
Cross selling
statistics
Test results
from training
knowledge of
product
offerings, sales
and service
Employee
satisfaction
survey
ABM
The determination of the cost of a product or service is vital at the strategic planning
level, as it is at the operational level. For example, organisations may need to evaluate
the market profitability and should they remain in it?
However the customer will perceive things from his/her own perspective. Essentially this
will involve making decisions about the value of the service or product to them compared
to its cost. Using a customer perspective for managing the business implies that
management will have to concern itself with some or all of the following issues:
v How does the customer perceive the quality of our product versus that of our
competitors?
v How can we continuously improve?
v Do the activities undertaken by the company produce the value that the customer
requires - activity analysis?
v What are the costs of these activities and are they being carried out efficiently?
v How well are the activities/processes being performed relative to competitors?
v What are the important things that we should be controlling?
Because the basis of this concern rests on the activities carried out this is called activity
based management.
In order to determine the cost of each activity it is necessary to determine how time is
spent and how costs build up. For example the profitability of a customer will depend not
only on the price and costs of the products purchased, but also on such factors as the
number of orders placed in a year, the number of calls made on the technical service
department and so on. This means that costs will have to be traced to this customer
from all over the company, not just the plant. This is done through cost drivers.
Cost drivers are those elements that give rise to the need for an activity such as the
number of orders for a sales order department, number of complaints for the customer
service department and so on. While there may be many identifiable cost drivers
management will need to identify the minimum set that will allow the costs to be
calculated.
Cost drivers apply at different levels:
Unit level
v Number of hours required to produce a product
Batch level
v These are costs such as machine set-up or inspection, these occur once per
batch
Processor product level
v These cover such items as engineering change orders which refer to a product or
process.
Organisation level
v They are incurred for supporting the continuing level of operations i.e. building
depreciation, division managers salary.
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Value of product
Features
What
Price
What
Features
Set Profit
Set Target Cost
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PERFORMAMCE PRISM
The performance prism was devised by Cranfield University and is one that considers all
organisational stakeholders, without necessarily focusing on one group. The
organisation considers what its stakeholders need and want from the organisation, and
consequently what the organisation needs and wants from its stakeholders.
There are five facets to The Performance Prism, namely
v Stakeholder satisfaction
v Stakeholder contribution
v Strategies
v Processes
v Capabilities
The Performance Prism is distinct from other models in that:
It is stakeholder driven, and not strategy driven.
The concept of stakeholders is more inclusive, and does not just consider shareholders
and customers
Success is seen as based on successful partnerships and inter-relationships between
the organisation and stakeholders
Measures can be generated and used for all levels within an organisation
When designing the prism, the five facets referred to above prompt specific questions
(and answers), namely
v Stakeholder satisfaction Who are the key stakeholders, what do they want and
need?
v Strategies What strategies do we need to put in place to satisfy the wants and
needs of our key stakeholders?
v Processes What critical processes do we need to put in place to enable us to
execute our strategies?
v Capabilities What capabilities do we need to put in place to allow us to operate,
maintain and enhance our processes?
v Stakeholder contribution What contributions do we want and need from our
stakeholders if we are to maintain and develop these capabilities?
TOTAL QUALITY MANAGEMENT (TQM)
TQM is a philosophy of quality management that originated in Japan in the
1950s, it seeks to integrate the quality management efforts of all groups in an
organisation and is considered to be a significant factor in Japanese global business
success.
The basic principle of TQM is that costs of prevention (getting things right first time) are
less than the costs of correction. This is contrasted with the traditional approach which
takes the view that that less than 100% quality is acceptable as the costs of reaching
100% outweigh the benefits.
There are four categories of TQM costs
Prevention costs
Costs incurred in preventing the production of products that do not conform to
specification. They include the costs of preventive maintenance, quality planning &
training & the extra costs of acquiring high quality raw materials.
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Appraisal costs
Costs incurred to ensure that materials & products meet quality conformance standards.
They include the costs of inspecting purchased parts, work in process & finished goods,
quality audits & field tests.
Internal failure costs
Costs associated with materials & products that feel to meet quality standards. They
include costs incurred before the product is despatched to the customer, such as the
costs of scrap, repair, downtime & work stoppages caused by defects.
External failure costs
Costs incurred when products or services fail to conform to requirements or satisfy
customer needs after they have been delivered. They include the costs of handling
customer complaints, warranty replacement, repairs of returned products & the costs
arising from a damaged company reputation. Costs within this category can have a
dramatic impact on future sales.
Opportunity costs
Advocates of TQM argue that the impact of less than 100% quality in terms of lost
potential for future sales also has to be taken into account.
TQM IMPLEMENTATION
In any implementation there are two things going on. First is the process being
implemented, in this case the TQM process and secondly the process of implementation
itself which is a process of change management. You have already covered the
management of change.
TQM and the management of change
To ensure successful implementation of a TQM programme it is important to use the
tools of TQM in the process. Because TQM is process oriented the best way to change
is to set up process-management teams who are tasked with solving real business
problems. To do this it is necessary to align the team-roles and responsibilities with the
process with which they are dealing. In this way the behaviours and attitudes are
changed as a result of doing something practical and not the other way round.
This technique of process-alignment has seven distinct steps:
1. Gain commitment to change through the organisation of the top team. The top team
must function as a team and if they do not some team-building training via
workshops should be carried out. They should discuss and agree a broad view of
what changes are needed, what must be improved and what the main business
problems are.
2. Develop a shared mission of vision of the business of what change is required. This
stage is the development of a mission statement that will help a co-ordinated flow of
analysis of processes that cut across existing organisational boundaries. The
mission should consist of an overarching purpose to which all stakeholders can
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3.
4.
5.
6.
agree, a set of core values, overarching strategies and the sorts of behaviours, firmly
grounded in TQM philosophy, based on the purpose, values and strategies.
Define the SMART objectives, which must be agreed by the team, as being the
quantifiable indicators of success. They should be tightly bound to the mission
statement
Develop the mission into its critical success factors (CSFs) to move it forward. The
CSFs are what the organisation must accomplish if it is to achieve its mission. They
can include things such as; motivated, skilled people; right-first-time suppliers;
products that meet market needs; and so on. The CSFs have been achieved when
their Key Performance Indicators (KPI) are met.
Break down the CSFs into the key processes and gain process ownership. All the
processes necessary to ensure a CSF is achieved should be listed (using a verbobject structure i.e. research the market)
Break down the critical processes into the sub-processes, activities and tasks and
form improvement teams around these. For example a business services company
may have as part of its mission the objective to Gain and maintain a position as the
UKs foremost business service company in the field of management training. One
CSF that relates to this would be Obtain a high level of awareness of our company
in the market place. One of the critical processes is to Promote, advertise and
communicate the companys business capability. One of the sub-processes could
be Prepare the company information pack. One of the activities relating to the subprocess would be Prepare one of the subject booklets for the pack. One of the
tasks necessary for this is To prepare the copy for the booklet.
Processes and teams can be linked as follows:
Quality council
Mission, CSFs, critical processes
Process quality teams
critical processes
Quality Improvement teams (QITs)
Sub-processes and tasks.
Quality circles/individuals
Tasks
The next step is to determine measurements of performance for all the elements
from process to task. These measurements should bear in mind the customer for
the output. So for example the leaflet writing task would need to contain clear
objectives and benefits as well as the programme.
7. Monitor and adjust the process alignment in response to difficulties in the change
process.
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55
50
100
150
200
30
30
30
30
20
60
60
60
0
40
65
90
-20
20
45
95
Minimum
30
20
-20
Maximum
30
60
90
95
Maximin
30
Contribution
Maximax
95
Minimax regret
Purchased kg
Demand kg
60
100
125
175
50
100
150
200
0
30
35
65
10
0
5
35
30
20
0
5
50
40
20
0
Qty purchased
50
100
150
200
Max regret
65
35
30
50
Minimax
30
56
Sales
Costs: Materials
Costs: Other
Contribution
Fixed costs
Profit
Provide Inc.
Sales
Costs: Materials
Contribution
Fixed costs
Profit
Qty
Containers
9,000
9,000
9,000
Unit data
$
30.00
14.00
5.00
Sales
270,000
(126,000)
( 45,000)
99,000
( 60,000)
39,000
Qty
Unit data
Containers $
36,000
14.00
36,000
7.00
Sales
504,000
(252,000)
252,000
( 80,000)
172,000
Existing
Containers
36,000
9,000
27,000
Revised
Containers
42,750
15,750
27,000
Change
%
75.0%
0.0%
Provide Inc.
Sales
Costs: Materials
Costs: Other
Contribution
Fixed costs
Profit
Initial profit b/f
Profit movement
Sales
Costs: Materials
Contribution
Fixed costs
Profit
57
Qty
Containers
15,750
15,750
15,750
Unit data
$
24.00
14.00
5.00
Sales
$
378,000
(220,500)
( 78,750)
78,750
( 60,000)
18,750
39,000
( 20,250)
Qty
Drums
42,750
42,750
Unit data
$
14.00
7.00
Sales
598,500
(299,250)
299,250
( 80,000)
219,250
172,000
47,250
238,000
211,000
27,000
Containers
16,000
6,750
-$20,250
-$3
Per container
$7
58
Year 2
$m
44.0
Year 3
$m
22.0
1.8
$60.00
$108.0
$64.8
-$40.0
2.0
$60.00
$120.0
$72.0
-$45.0
2.5
$60.00
$150.0
$90.0
-$50.0
EBITDA: million
(Contribution less incremental costs)
$24.8
$27.0
$40.0
-$5.0
-$5.0
$3.0
$17.8
$27.0
$47.0
Less: depreciation
Profit
(NCF minus depreciation)
-$22.0
-$4.2
-$22.0
$5.0
-$22.0
$25.0
-$7.9
-$5.3
-$2.6
-$12.1
-$0.3
$22.4
-6.4%
11.4%
113.6%
$5.0
$5.0
-$3.0
$66.0
2.402
$27.5
59
Year 1
$m
66.0
Year 2
$m
44.0
Year 3
$m
22.0
-7.9
-5.3
-2.6
19.6
22.2
24.8
Year 1
$m
17.8
-19.6
Year 2
$m
27.0
-22.2
Year 3
$m
47.0
-24.8
-1.8
4.8
22.2
-7.9
-5.3
-2.6
-9.7
-0.5
19.5
-2.7%
7.3%
33.6%
Year 1
$m
Year 2
$m
Year 3
$m
$17.8
$27.0
$47.0
NPV
Investment
Year 0
$m
-$66.0
-$66.0
1.000
$17.8
0.893
$27.0
0.797
$47.0
0.712
Present value
NPV
-$66.0
$4.9
$15.9
$21.5
$33.5
Calculate IRR
Year 0
Year 1
Year 2
Year 3
Cash flow
$m
-66.0
17.8
27.0
47.0
Discount
factor
12.0%
1.000
0.893
0.797
0.712
PV
$m
-66.0
15.9
21.5
33.5
Discount
factor
20.0%
1.000
0.833
0.694
0.579
4.9
IRR
12% +
(4.9
) (20-12)%
(4.9-(-5.2)
60
PV
$m
-66.0
14.8
18.8
27.2
-5.2
15.9%