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S T U D Y PAPER F5 T E PERFORMANCE MANAGEMENT X T In this edition approved by ACCA x We ddiscuss the bbest strategies for studying for ACCA exams x We hhighlight the mmost important elements in the syllabus and the kkey skills you will need x We ssignpost how each chapter links to the syllabus and the study guide x We pprovide lots of eexam focus points demonstrating what the examiner will want you to do x We eemphasise key points in regular ffast forward summaries x We ttest your knowledge of what you've studied in qquick quizzes xx ThiNganHang.comWe eWe rexamine your understanding in our ereference all the important topics in our fexam question bankfull index BPP's i-Learn and i-Pass products also support this paper. FOR EXAMS IN DECEMBER 2009 AND JUNE 2010 ThiNganHang.com
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First edition 2007 Third edition June 2009 ISBN 9780 7517 6367 6 (Previous ISBN 9780 7517 4726 3) British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library All our rights reserved. No part of this publication may be Published by reproduced, stored in a retrieval system or transmitted, in BPP Learning Media Ltd any form or by any means, electronic, mechanical, BPP House, Aldine Place photocopying, recording or otherwise, without the prior London W12 8AA written permission of BPP Learning Media Ltd. www.bpp.com/learningmedia We are grateful to the Association of Chartered Certified Accountants for permission to reproduce past Printed in the United Kindgom examination questions. The suggested solutions in the exam answer bank have been prepared by BPP Learning Media Ltd, except where otherwise stated. Your learning materials, published by BPPLearning Media Ltd, are printed on papersourced from sustainable, managed forests.ThiNganHang.com © BPP Learning Media Ltd 2009 ii ThiNganHang.com
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Contents Page Introduction How the BPP ACCA-approved Study Text can help you pass v Studying F5 vii The exam paper and exam formulae viii Part A Specialist cost and management accounting techniques 1 Costing 3 2a Activity based costing 21 2b Target costing 35 2c Lifecycle costing 41 2d Backflush accounting 49 2e Throughput accounting 55 Part B Decision-making techniques 3 Limiting factor analysis 69 4 Pricing decisions 91 5 Short-term decisions 117 6 Risk and uncertainty 131 Part C Budgeting 7 Objectives of budgetary control 147 8 Budgetary systems 163 9 Quantitative analysis in budgeting 179 Part D Standard costing and variances analysis 10 Budgeting and standard costing 211 11 Variance analysis 231 12 Behavioural aspects of standard costing 259 Part E Performance measurement and control 13 Performance measurement 277 14 Divisional performance measures 303 15 Further performance management 319 Exam question bank 335 Exam answer bank 349 Index 387 ThiNganHang.comReview form and free prize draw Contents iii ThiNganHang.com
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A note about copyright Dear Customer What does the little © mean and why does it matter? Your market-leading BPP books, course materials and e-learning materials do not write and update themselves. People write them: on their own behalf or as employees of an organisation that invests in this activity. Copyright law protects their livelihoods. It does so by creating rights over the use of the content. Breach of copyright is a form of theft – as well as being a criminal offence in some jurisdictions, it is potentially a serious breach of professional ethics. With current technology, things might seem a bit hazy but, basically, without the express permission of BPP Learning Media: x Photocopying our materials is a breach of copyright x Scanning, ripcasting or conversion of our digital materials into different file formats, uploading them to facebook or emailing them to your friends is a breach of copyright You can, of course, sell your books, in the form in which you have bought them – once you have finished with them. (Is this fair to your fellow students? We update for a reason.) But the e-products are sold on a single user licence basis: we do not supply ‘unlock’ codes to people who have bought them second-hand. And what about outside the UK? BPP Learning Media strives to make our materials available at prices students can afford by local printing arrangements, pricing policies and partnerships which are clearly listed on our website. A tiny minority ignore this and indulge in criminal activity by illegally photocopying our material or supporting organisations that do. If they act illegally and unethically in one area, can you really trust them? ThiNganHang.com iv ThiNganHang.com
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How the BPP ACCA-approved Study Text can help you pass your exams – AND help you with your Practical Experience Requirement! NEW FEATURE – the PER alert! Before you can qualify as an ACCA member, you do not only have to pass all your exams but also fulfil a three year practical experience requirement (PER). To help you to recognise areas of the syllabus that you might be able to apply in the workplace to achieve different performance objectives, we have introduced the ‘PER alert’ feature. You will find this feature throughout the Study Text to remind you that what you are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement. Tackling studying Studying can be a daunting prospect, particularly when you have lots of other commitments. The different features of the text, the purposes of which are explained fully on the Chapter features page, will help you whilst studying and improve your chances of exam success. Developing exam awareness Our Texts are completely focused on helping you pass your exam. Our advice on Studying F5 outlines the content of the paper, the necessary skills the examiner expects you to demonstrate and any brought forward knowledge you are expected to have. Exam focus points are included within the chapters to highlight when and how specific topics were examined, or how they might be examined in the future. Using the Syllabus and Study Guide You can find the syllabus, Study Guide and other useful resources for F5 on the ACCA web site: www.accaglobal.com/students/study_exams/qualifications/acca_choose/acca/professional/pm/ The Study Text covers all aspects of the syllabus to ensure you are as fully prepared for the exam as possible. ThiNganHang.comTesting what you can doTesting yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt. We include Questions – lots of them - both within chapters and in the Exam Question Bank, as well as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content. Introduction v ThiNganHang.com
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Chapter features Each chapter contains a number of helpful features to guide you through each topic. Topic list Tells you what you will be studying in this chapter and the Topic list Syllabusreference relevant section numbers, together the ACCA syllabus references. Introduction Puts the chapter content in the context of the syllabus as a whole. Study Guide Links the chapter content with ACCA guidance. Exam Guide Highlights how examinable the chapter content is likely to be and the ways in which it could be examined. Knowledge brought forward from earlier studies What you are assumed to know from previous studies/exams. Summarises the content of main chapter headings, FAST FORWARD allowing you to preview and review each section easily. Examples Demonstrate how to apply key knowledge and techniques. Definitions of important concepts that can often earn you Key terms easy marks in exams. Tell you when and how specific topics were examined, or Exam focus points how they may be examined in the future. Formulae that are not given in the exam but which have to Formula to learn be learnt. This is a new feature that gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER). Question Give you essential practice of techniques covered in the chapter. Case Study Provide real world examples of theories and techniques. ThiNganHang.comChapter Roundup A full list of the Fast Forwards included in the chapterproviding an easy source of review. , Quick Quiz A quick test of your knowledge of the main topics in the chapter. Found at the back of the Study Text with more Exam Question Bank comprehensive chapter questions. Cross referenced for easy navigation. vi Introduction ThiNganHang.com
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Studying F5 The examiner of F5 wants candidates to have an ability to apply management accounting in business environments. The key question you need to be able to answer is 'what does it all actually mean?' Modern technology is capable of producing vast amounts of management accounting information but it has to be used to help managers to make good decisions and manage effectively. The emphasis in this paper is therefore on practical elements and application to the real world. The examiner does not want to trick you and papers will be fair. 1 What the paper is about The aim of this syllabus is to develop knowledge and skills in the application of management accounting techniques. It covers modern techniques, decision making, budgeting and standard costing, concluding with how a business should be managed and controlled. F5 is the middle paper in the management accounting section of the qualification structure. F2 concerns just techniques and P5 thinks strategically and considers environmental factors. F5 requires you to be able to apply techniques and think about their impact on the organisation. 2 An explanation of the skills you are expected to demonstrate x You are expected to have a core of management accounting knowledge from your previous studies eg papers 1.2 (old syllabus) or F2 (new syllabus) x You will be required to carry out calculations, with clear workings and a logical structure x You will be required to interpret data x You will be required to explain management accounting techniques and discuss whether they are appropriate for a particular organisation x You must be able to apply your skills in a practical context 3 How you can improve your chances of passing this paper x There is no choice in this paper, all questions have to be answered. You must therefore study the entire syllabus, there are no short-cuts x Practising questions under timed conditions is essential. BPP's revision kit contains 20 mark questions on all areas of the syllabus x Questions will be based on simple scenarios and answers must be focused and specific to the ThiNganHang.comorganisation x Answer plans will help you to focus on the requirements of the question and enable you to manage your time effectively x Answer all parts of the question. Even if you cannot do all of the calculation elements, you will still be able to gain marks in the discussion parts x Make sure your answers focus on practical applications of management accounting, common sense is essential! x Keep an eye out for articles as this is a new paper and the examiner will use Student Accountant to communicate with students x Read journals etc to pick up on ways in which real organisations apply management accounting and think about your own organisation if that is relevant Introduction vii ThiNganHang.com
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4 Brought forward knowledge You will need to have a good working knowledge of basic management accounting from 1.2 (old syllabus) or F2 (new syllabus). Chapter 1 of this Study Text revises costing and brought forward knowledge is identified throughout the text. If you struggle with the examples and questions used to revise this knowledge, you must go back and revisit your previous work. The examiner will assume you know this material and it may form part of an exam question. The exam paper The exam is a three-hour paper containing five compulsory 20 mark questions. There will be a mixture of calculations and discussion and the examiner's aim is to cover as much of the syllabus as possible. Analysis of past papers Below provides an overview of the syllabus and details of when each element has been examined. Further details can be found in the Exam Focus Points in the relevant chapters. Covered in Text Dec June Dec Pilot chapter 2008 2008 2007 Paper SPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 2a Activity based costing 4 1 2b Target costing 1 2c Life cycle costing 4 2d Backflush accounting 2e Throughput accounting DECISION-MAKING TECHNIQUES 3 Multi-limiting factors and the use of linear programming and 2 shadow pricing 4 Pricing decisions 5 Make-or-buy and other short-term decisions 4 6 Dealing with risk and uncertainty in decision-making 2 BUDGETING 7 Objectives 8 Budgetary systems 8 Types of budget 4 9 Quantitative analysis in budgeting 3 3 7 Behavioural aspects of budgeting ThiNganHang.comSTANDARD COSTING AND VARIANCE ANALYSIS 10 Budgeting and standard costing 4 11 Basic variances and operating systems 1 3 2 11 Material mix and yield variances 2 12 Planning and operational variances 3 12 Behavioural aspects of standard costing PERFORMANCE MEASUREMENT AND CONTROL 13 The scope of performance measurement 1 3 2 4 14 Divisional performance and transfer pricing 1 15 Performance analysis in not-for-profit organisations and the public sector viii Introduction ThiNganHang.com
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Exam formulae Set out below are the formulae you will be given in the exam. If you are not sure what the symbols mean, or how the formulae are used, you should refer to the appropriate chapter in this Study Text. Chapter in Study Text Learning curve 9 Y = axb Where y = average cost per batch a = cost of first batch x = total number of batches produced b = learning factor (log LR/log 2) LR = the learning rate as a decimal Regression analysis 9 y = a + bx n¦ xy ¦ x ¦ y b = n¦ x2 (¦ x)2 ¦ y b¦ x a = n n Demand curve 4 P = a – bQ changeinprice b = changeinquantity a = price when Q = 0 ThiNganHang.com Introduction ix ThiNganHang.com
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Costing Topic list 1 Costing 2 The problem of overheads 3 A revision of absorption costing 4 Overhead absorption 5 Marginal costing 6 Absorption costing and marginal costing compared Introduction Part A of this Study Text looks at specialist cost and management accounting techniques. This chapter serves as a revision of concepts you will have covered in your previous studies. In the following chapter we will be looking at more complex techniques so it is important that you are familiar with the key concepts and terminology in this chapter.ThiNganHang.com 3 ThiNganHang.com
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Exam guide This chapter serves as an introduction to your study of cost and management accounting techniques, as knowledge is assumed from Paper F2 Management Accounting and is still examinable at this level. Questions in this paper will focus on interpretation rather than doing calculations. 1 Costing FAST FORWARD Costing is the process of determining the costs of products, services or activities. Cost accounting is used to determine the cost of products, jobs or services (whatever the organisation happens to be involved in). Such costs have to be built up using a process known as cost accumulation. In your earlier studies you will have learnt how to accumulate the various cost elements which make up total cost. Absorption costing cost accumulation system 2 The problem of overheads FAST FORWARD ThiNganHang.comIndirect costscannot be traced directly to the product or service.share of these costs into the cost of a unit of product or service provided., or overheads, are costs incurred in making a product or providing a service, but whichAbsorption costing is a means of incorporating a fair If a company manufactures a product, the cost of the product will include the cost of the raw materials and components used in it and cost of the labour effort required to make it. These are direct costs of the product. The company would, however, incur many other costs in making the product, which are not directly attributable to a single product, but which are incurred generally in the process of manufacturing a large number of product units. These are indirect costs or overheads. Such costs include the following. x Factory rent and rates x Supervision costs x Machine depreciation x Heating and lighting 4 1: Costing ~ Part A Specialist cost and management accounting techniques ThiNganHang.com
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Key terms A direct cost is a cost that can be traced in full to the product, service or department that is being costed. An indirect cost or overhead is a cost that is incurred in the course of making a product, providing a service or running a department, but which cannot be traced directly and in full to the product, service or department. In some companies, the overheads cost might greatly exceed the direct production costs. It might seem unreasonable to ignore indirect costs entirely when accumulating the costs of making a product, and yet there cannot be a completely satisfactory way of sharing out indirect costs between the many different items of production which benefit from them. 2.1 Using absorption costing to deal with the problem of overheads Traditionally, the view has been that a fair share of overheads should be added to the cost of units produced. This fair share will include a portion of all production overhead expenditure and possibly administration and marketing overheads too. This is the view embodied in the principles of absorption costing. 2.1.1 Theoretical justification for using absorption costing All production overheads are incurred in the production of the organisation's output and so each unit of the product receives some benefit from these costs. Each unit of output should therefore be charged with some of the overhead costs. 2.1.2 Practical reasons for using absorption costing (a) Inventory valuations Inventory in hand must be valued for two reasons. (i) For the closing inventory figure in the balance sheet (ii) For the cost of sales figure in the income statement The valuation of inventories will affect profitability during a period because of the way in which the cost of sales is calculated. Cost of goods sold = cost of goods produced + the value of opening inventories – the value of closing inventories (b) Pricing decisions Many companies attempt to set selling prices by calculating the full cost of production or sales of each product, and then adding a margin for profit. 'Full cost plus pricing' can be particularly useful for companies which do jobbing or contract work, where each job or contract is different, so that a standard unit sales price cannot be fixed. Without using absorption costing, a full cost is difficult to ascertain. ThiNganHang.com(c) Establishing the profitability of different products This argument in favour of absorption costing states that if a company sells more than one product, it will be difficult to judge how profitable each individual product is, unless overhead costs are shared on a fair basis and charged to the cost of sales of each product. 2.2 Using marginal costing to deal with the problem of overheads For many purposes absorption costing is less useful as a costing method than marginal costing. In some situations, absorption costing can be misleading in the information it supplies. Advocates of marginal costing take the view that only the variable costs of making and selling a product or service should be identified. Fixed costs should be dealt with separately and treated as a cost of the accounting period rather than shared out somehow between units produced. Some overhead costs are, Part A Specialist cost and management accounting techniques ~ 1: Costing 5 ThiNganHang.com
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however, variable costs which increase as the total level of activity rises and so the marginal cost of production and sales should include an amount for variable overheads. 3 A revision of absorption costing FAST FORWARD Absorption costing is a traditional approach to dealing with overheads, involving three stages: allocation, apportionment and absorption. Apportionment has two stages, general overhead apportionment and service department cost apportionment. Key term Absorption costing is a method of product costing which aims to include in the total cost of a product (unit, job and so on) an appropriate share of an organisation's total overhead, which is generally taken to mean an amount which reflects the amount of time and effort that has gone into producing the product. You should have covered absorption costing in your earlier studies. We will therefore summarise the simpler points of the topic but will go into some detail on the more complex areas to refresh your memory. Knowledge brought forward from earlier studies Absorption costing x Product costs are built up using absorption costing by a process of allocation, apportionment and overhead absorption. x Allocation is the process by which whole cost items are charged directly to a cost unit or cost centre. Direct costs are allocated directly to cost units. Overheads clearly identifiable with cost centres are allocated to those cost centres but costs which cannot be identified with one particular cost centre are allocated to general overhead cost centres. The cost of a warehouse security guard would therefore be charged to the warehouse cost centre but heating and lighting costs would be charged to a general overhead cost centre. x The first stage of overhead apportionment involves sharing out (or apportioning) the overheads within general overhead cost centres between the other cost centres using a fair basis of apportionment (such as floor area occupied by each cost centre for heating and lighting costs). x The second stage of overhead apportionment is to apportion the costs of service cost centres (both directly allocated and apportioned costs) to production cost centres. x The final stage in absorption costing is the absorption into product costs (using overhead absorption rates) of the overheads which have been allocated and apportioned to the production cost centres. x Costs allocated and apportioned to non-production cost centres are usually deducted from the full cost of production to arrive at the cost of sales. ThiNganHang.comQuestion Cost apportionment Briefly discuss the type of factors which could affect the choice of the bases an organisation can use to apportion service department costs. Answer (a) The type of service being provided (b) The amount of overhead expenditure involved (c) The number of departments benefiting from the service 6 1: Costing ~ Part A Specialist cost and management accounting techniques ThiNganHang.com
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(d) The ability to be able to produce realistic estimates of the usage of the service (e) The resulting costs and benefits Question More cost apportionment A company is preparing its production overhead budgets and determining the apportionment of those overheads to products. Cost centre expenses and related information have been budgeted as follows. Machine Machine Mainten- Total shop A shop B Assembly Canteen ance $ $ $ $ $ $ Indirect wages 78,560 8,586 9,190 15,674 29,650 15,460 Consumable materials 16,900 6,400 8,700 1,200 600 – Rent and rates 16,700 Buildings insurance 2,400 Power 8,600 Heat and light 3,400 Depreciation (machinery) 40,200 Value of machinery 402,000 201,000 179,000 22,000 – – Power usage (%) 100 55 40 3 – 2 Direct labour (hours) 35,000 8,000 6,200 20,800 – – Machine usage (hours) 25,200 7,200 18,000 – – – Area (sq ft) 45,000 10,000 12,000 15,000 6,000 2,000 Required Using the direct apportionment to production departments method and bases of apportionment which you consider most appropriate from the information provided, calculate overhead totals for the three production departments. Answer Main- Basis of Total A B Assembly Canteen tenance apportionment $ $ $ $ $ $ Indirect wages 78,560 8,586 9,190 15,674 29,650 15,460 Actual Consumable materials 16,900 6,400 8,700 1,200 600 – Actual Rent and rates 16,700 3,711 4,453 5,567 2,227 742 Area Insurance 2,400 533 640 800 320 107 Area Power 8,600 4,730 3,440 258 – 172 Usage Heat and light 3,400 756 907 1,133 453 151 Area Depreciation 40,200 20,100 17,900 2,200 – – Val of mach 166,760 44,816 45,230 26,832 33,250 16,632 Reallocate – 7,600 5,890 19,760 (33,250) – Direct labour ThiNganHang.comReallocateTotals 166,760– 57,1684,752 11,88063,000 46,592– –– (16,632–) Mach usage 4 Overhead absorption FAST FORWARD After apportionment, overheads are absorbed into products using an appropriate absorption rate based on budgeted costs and budgeted activity levels. Having allocated and/or apportioned all overheads, the next stage in absorption costing is to add them to, or absorb them into, the cost of production or sales. Part A Specialist cost and management accounting techniques ~ 1: Costing 7 ThiNganHang.com
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4.1 Use of a predetermined absorption rate Knowledge brought forward from earlier studies Step 1 The overhead likely to be incurred during the coming year is estimated. Step 2 The total hours, units or direct costs on which the overhead absorption rates are based (activity levels) are estimated. Step 3 Absorption rate = estimated overhead y budgeted activity level 4.2 Choosing the appropriate absorption base Question Absorption bases List as many possible bases of absorption (or 'overhead recovery rates') which you can think of. Answer (a) A percentage of direct materials cost (b) A percentage of direct labour cost (c) A percentage of prime cost (d) A percentage of factory cost (for administration overhead) (e) A percentage of sales or factory cost (for selling and distribution overhead) (f) A rate per machine hour (g) A rate per direct labour hour (h) A rate per unit The choice of an absorption basis is a matter of judgement and common sense. There are no strict rules or formulae involved. But the basis should realistically reflect the characteristics of a given cost centre, avoid undue anomalies and be 'fair'. The choice will be significant in determining the cost of individual products, but the total cost of production overheads is the budgeted overhead expenditure, no matter what basis of absorption is selected. It is the relative share of overhead costs borne by individual products and jobs which is affected. Question Absorption rates Using the information in and the results of the question on page 7, determine budgeted overhead ThiNganHang.comabsorption rates for each of the production departments using appropriate bases of absorption. Answer Machine shop A: $57,168/7,200 = $7.94 per machine hour Machine shop B: $63,000/18,000 = $3.50 per machine hour Assembly: $46,592/20,800 = $2.24 per direct labour hour 4.3 Over and under absorption of overheads FAST FORWARD Under-/over-absorbed overhead occurs when overheads incurred do not equal overheads absorbed. 8 1: Costing ~ Part A Specialist cost and management accounting techniques ThiNganHang.com
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The rate of overhead absorption is based on estimates (of both numerator and denominator) and it is quite likely that either one or both of the estimates will not agree with what actually occurs. Actual overheads incurred will probably be either greater than or less than overheads absorbed into the cost of production, and so it is almost inevitable that at the end of the accounting year there will have been an over absorption or under absorption of the overhead actually incurred. x Over absorption means that the overheads charged to the cost of sales are greater than the overheads actually incurred. x Under absorption means that insufficient overheads have been included in the cost of sales. Suppose that the budgeted overhead in a production department is $80,000 and the budgeted activity is 40,000 direct labour hours, the overhead recovery rate (using a direct labour hour basis) would be $2 per direct labour hour. Actual overheads in the period are, say $84,000 and 45,000 direct labour hours are worked. $ Overhead incurred (actual) 84,000 Overhead absorbed (45,000 u $2) 90,000 Over-absorption of overhead 6,000 In this example, the cost of production has been charged with $6,000 more than was actually spent and so the cost that is recorded will be too high. The over-absorbed overhead will be an adjustment to the profit and loss account at the end of the accounting period to reconcile the overheads charged to the actual overhead. Question Under and over-absorption The total production overhead expenditure of the company in the questions above was $176,533 and its actual activity was as follows. Machine shop A Machine shop B Assembly Direct labour hours 8,200 6,500 21,900 Machine usage hours 7,300 18,700 – Required Using the information in and results of the previous questions, calculate the under- or over-absorption of overheads. Answer $ $ Actual expenditure 176,533 Overhead absorbed Machine shop A 7,300 hrs u $7.94 57,962 Machine shop B 18,700 hrs u $3.50 65,450 Assembly 21,900 hrs u $2.24 49,056 ThiNganHang.comUnder-absorbed overhead 172,4684,065 4.4 The reasons for under-/over-absorbed overhead The overhead absorption rate is predetermined from budget estimates of overhead cost and activity level. Under or over recovery of overhead will occur in the following circumstances. x Actual overhead costs are different from budgeted overheads. x The actual activity level is different from the budgeted activity level. x Actual overhead costs and actual activity level differ from those budgeted. Part A Specialist cost and management accounting techniques ~ 1: Costing 9 ThiNganHang.com
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