Performance Management Study System

7/27/2019 Performance Management Study System

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2012EDITION | Study System

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ACCAPaper P5 |ADVANCED PERFORMANCE

MANAGEMENT


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2012 DeVry/Becker Educational Development Corp. All rights reserved.

ACCA

PAPER P5

ADVANCED PERFORMANCE MANAGEMENT

STUDY SYSTEM

JUNE 2012


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2012 DeVry/Becker Educational Development Corp. All rights reserved.

No responsibility for loss occasioned to any person acting or refraining from action as a result of anymaterial in this publication can be accepted by the author, editor or publisher.

This training material has been published and prepared by Accountancy Tuition Centre (InternationalHoldings) Limited

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Copyright 2012 DeVry/Becker Educational Development Corp. All rights reserved.

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SESSION 00 CONTENTS

2012 DeVry/Becker Educational Development Corp. All rights reserved. (iii)

CONTENTS

Page

Introduction (iv)

Syllabus (v)

Study Guide (ix)

Exam technique (xvi)

1 Introduction to Strategic management accounting 0101

2 Performance management and control of the organisation 0201

3 Changes in business structure and management accounting 0301

4 Effect of IT on modern management accounting 0401

5 Other environmental and ethical issues 0501

6 External influences on organisational performance 0601

7 Performance management information systems 0701

8 Information recording and reporting 0801

9 The performance hierarchy 0901

10 Performance measurement in the private sector 1001

11 Divisional performance evaluation 1101

12 Transfer pricing 1201

13 Not-for-profit organisations 1301

14 Non-financial performance indicators and quality 1401

15 Human aspects of performance management 1501

16 Alternative views of performance management 1601

17 Complex business structures 1701

18 Current developments 1801

Index 1901


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SESSION 00 INTRODUCTION

(iv) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

Introduction

This Study System has been specifically written for the Association of Chartered CertifiedAccountants fundamentals level examination, Paper P5Advanced PerformanceManagement.

It provides comprehensive coverage of the core syllabus areas and is designed to be usedboth as a reference text and and is designed to be used both as a reference text and as toprovide you with the knowledge, skill and confidence to succeed in your ACCAexaminations.

About the author: Nick Ryan is ATC Internationals lead tutor in performance managementand has more than 10 years experience in delivering ACCA exam-based training.

How to use this Study System

You should first read through the syllabus, study guide and approach to examining the

syllabus provided in this session to familiarise you with the content of this paper. Thesessions which follow include:

An overview diagram at the beginning of each session.This provides a visual summary of the topics covered in each Sessionand how they are related.

The body of knowledge which underpins the syllabus. Features of thetext include:

Definitions Terms are defined as they are introduced.

Illustrations These are to be read as part of the text. Any solutionsto numerical illustrations follow on immediately.

Examples These should be attempted using the proformasolution provided (where applicable).

Key points Attention is drawn to fundamental rules andunderlying concepts and principles.

Commentaries These provide additional information.

Focus These are the learning outcomes relevant to thesession, as published in ACCAs Study Guide.

Example solutions are presented at the end of each session.A bank of practice questions is contained in the Study Question Bank provided. These arelinked to the topics of each session and should be attempted after studying each session.


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SESSION 00 SYLLABUS

2012 DeVry/Becker Educational Development Corp. All rights reserved. (v)

SYLLABUS

Aim

To apply relevant knowledge, skills and exercise professional judgement in selecting and

applying strategic management accounting techniques in different business contexts and tocontribute to the evaluation of the performance of an organisation and its strategicdevelopment.

Main capabilities

On successful completion of this paper, candidates should be able to:

A Use strategic planning and control models to plan and monitor organisationalperformance;

B Assess and identify relevant macro economic, fiscal and market factors and key externalinfluences on organisational performance;

C Identify and evaluate the design features of effective performance managementinformation and monitoring systems;

D Apply appropriate strategic performance measurement techniques in evaluating andimproving organisational performance;

E Advise clients and senior management on strategic business performance evaluationand on recognising vulnerability to corporate failure;

F Identify and assess the impact of current developments in management accounting andperformance management on measuring, evaluating and improving organisationalperformance.

Syllabus structure

APM (P5)

PM (F5)

MA (F2)

BA (P3)


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SESSION 00 SYLLABUS

(vi) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

Relational diagram of main capabilities

Strategic planning and control (A)

Economic, fiscal, market and environmental factors (B)

Performance measurementsystems and design (C)

Performance evaluation and corporate failure (E)

Current developments and emerging issues in management accountingand performance management (F)

Strategic performancemeasurement (D)

Rationale

The Advanced Performance Management syllabus further develops key aspects introducedin Paper F5, Performance Management, at the skills level and draws on aspects of the materialcovered from a more strategic and operational planning perspective in Paper P3, Business

Analysis.

The syllabus introduces candidates to the strategic role of management accounting as adiscipline for planning and controlling performance so that strategic objectives can be set,monitored and controlled. It also covers the impact of external factors on strategicmanagement issues, such as macro economic, fiscal, market and environmental impacts onperformance. From appreciating the strategic context of performance management and theimpact of wider factors, the syllabus examines, at an operational level, the issues relating to

performance measurement systems and their design.

The syllabus then moves from performance management systems and their design to thescope and application of high-level performance measurement techniques in a variety ofcontexts, including not-for-profit organisations and multinational businesses. Havingcovered the strategic aspects of performance management and operational systems for themeasurement and control of performance in a variety of contexts, candidates are thenexpected to synthesise this knowledge in the role of an advisor to senior management orindependent clients on how to assess and control the performance of an entity, including therecognition of whether a business is facing difficulties or possibly failure.

Finally, the syllabus deals with current developments in performance management and withemerging issues as they might affect or influence the management of performance withinorganisations.


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SESSION 00 SYLLABUS

2012 DeVry/Becker Educational Development Corp. All rights reserved. (vii)

DETAILED SYLLABUS

A. Strategic planning and control

1. Introduction to strategic management accounting

2. Performance management and control of the organisation

3. Changes in business structure and management accounting

4. Effect of Information Technology (IT) on strategic management accounting

5. Other environmental and ethical issues

B. External influences on organisational Performance

1. Changing business environment

2. Impact of external factors on strategy and performance

C. Performance measurement systems and design

1. Performance management information systems

2. Sources of management information

3. Recording and processing methods

4. Management reports

D. Strategic performance measurement

1. Performance hierarchy2. Strategic performance measures in private sector

3. Divisional performance and transfer pricing issues

4. Strategic performance measures in not-for-profit organisations

5. Non-financial performance indictors

6. The role of quality in management information and performance measurement systems

7. Performance measurement and strategic human resource management issues

8. Performance measurement and the reward systems

9. Other behavioural aspects of performance measurement

E. Performance evaluation and corporate failure

1. Alternative views of performance measurement and management

2. Strategic performance issues in complex business structures

3. Predicting and preventing corporate failure

F. Current developments and emerging issues performance management

1. Current developments in management accounting techniques

2. Current issues and trends in performance management


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SESSION 00 SYLLABUS

(viii) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

Approach to examining the syllabus

Paper P5 builds on paper F5, Performance Management, and candidates are expected to have athorough understanding of the paper F5 syllabus. In addition, candidates will also berequired to apply the principles and techniques covered in paper F2,Management

Accounting.

Paper P5 has a link with Paper P3, Business Analysis, in the areas of strategic planning andcontrol and performance measurement

Structure of the examination paper

The examination paper will comprise two sections:

Section A

Section A will comprise two compulsory questions comprising between 50 and 70 marks intotal. Each question will comprise of between 25 and 40 marks.

Section B

In section B candidates will be asked to answer two from three questions comprising ofbetween 15 and 25 marks each.

Total 100 marks

ACCA Support

For examiners reports, guidance and technical articles relevant to this paper seehttp://www2.accaglobal.com/students/acca/exams/p5/

The ACCAs Study Guide which follows is referenced to the Sessions in this Study System.


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SESSION 00 STUDY GUIDE

2012 DeVry/Becker Educational Development Corp. All rights reserved. (ix)

STUDY GUIDE

A STRATEGIC PLANNING AND

CONTROL

1. Introduction to strategicmanagement accounting

Explain the role of strategicperformance management instrategic planning and control.

Discuss the role of corporateplanning in clarifying corporateobjectives, making strategicdecisions and checking progresstowards the objectives.

Compare planning and controlbetween the strategic andoperational levels within a businessentity.

Assess the use of strategicmanagement accounting in thecontext of multinational companies.

Discuss the scope for potentialconflict between strategic businessplans and short-term localised

decisions.

Evaluate how SWOT analysis mayassist in the performancemanagement process.

Evaluate the methods of benchmarking performance.

2. Performance management andcontrol of the organisation

Evaluate the strengths andweaknesses of alternativebudgeting models and comparesuch techniques as fixed andflexible, rolling, activity based, zerobased and incremental.

Assess how budgeting may differ innot-for-profit organisations fromprofit-seeking organisations.

Evaluate the impact to anorganisation of a move beyond

budgeting.

Ref:

1

2

3. Changes in business structure andmanagement accounting

Identify and discuss the particularinformation needs of organisationsadopting a functional, divisional ornetwork form and the implicationsfor performance management.

Assess the influence of BusinessProcess Re-engineering on systemsdevelopment and improvements inorganisational performance.

Discuss the concept of businessintegration and the linkage betweenpeople, operations, strategy andtechnology.

Identify and discuss the requiredchanges in management accountingsystems as a consequence ofempowering staff to manage sectorsof a business.

4. Effect of Information Technology(IT) on strategic managementaccounting

Assess the changing accountingneeds of modern service orientatedbusinesses compared with theneeds of traditional manufacturingindustry.

Discuss how IT systems provide theopportunity for instant access to

management accounting datathroughout the organisation andtheir potential impact on businessperformance.

Discuss how IT systems facilitatethe remote input of managementaccounting data in an acceptableformat by non-finance specialists.

Ref:

3

4


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Explain how information systemsprovide instant access to previouslyunavailable data that can be used

for benchmarking and controlpurposes and help improvebusiness performance.

Assess the need for businesses tocontinually refine and develop theirmanagement accounting andinformation systems if they are tomaintain or improve theirperformance in an increasinglycompetitive and global market.

5. Other environmental and ethicalissues

Discuss the ways in whichstakeholder groups operate andhow they affect an organisation andits strategy formulation andimplementation.

Discuss the ethical issues that mayimpact on strategy formulation andbusiness performance.

Discuss the ways in whichstakeholder groups may influencebusiness performance.

B EXTERNAL INFLUENCES ONORGANISATIONALPERFORMANCE

1. Changing business environment

Assess the continuing effectivenessof traditional management

accounting techniques within arapidly changing businessenvironment.

Evaluate how risk and uncertaintyplay an important role in long termstrategic planning and decision-making that relies upon forecasts ofexogenous variables.

Ref:

5

6

2. Impact of external factors onstrategy and performance

Discuss the need to consider theenvironment in which an

organisation is operating whenassessing its performance,including:

Political climate Market conditions Funding.

Assess the impact of governmentalregulations and policies onperformance measurement

techniques used and theperformance levels achieved (forexample, in the case of utilityservices and former statemonopolies).

C PERFORMANCEMEASUREMENT SYSTEMS AND

DESIGN

1. Performance managementinformation systems

Identify the accounting informationrequirements and describe thedifferent types of informationsystems used for strategic planning,management control andoperational control and decision-making.

Discuss, with reference toperformance management, ways inwhich the information

requirements of a managementstructure are affected by thefeatures of the structure.

Evaluate the compatibility of theobjectives of managementaccounting and managementaccounting information.

Ref:6

7


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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xi)

Discuss the integration ofmanagement accountinginformation within an overall

information system, for example theuse of enterprise resource planningsystems.

Evaluate whether the managementinformation systems are lean andvalue of the information that theyprovide.

Define and discuss the merits of,and potential problems with, openand closed systems with regard to

the needs of performancemanagement.

Highlight the ways in whichcontingent (internal and external)factors influence managementaccounting and its design and use.

Advise how anticipated humanbehaviour will influence the designof a management accountingsystem.

Discuss the impact of responsibilityaccounting on informationrequirements.

2. Sources of managementinformation

Identify and discuss the principalinternal and external sources ofmanagement accountinginformation.

Demonstrate how these principalsources of management informationmight be used for control purposes.

Identify and discuss the direct datacapture and process costs ofmanagement accountinginformation.

Identify and discuss the indirectcosts of producing information.

Discuss the limitations of usingexternally generated information.

Ref:

8

Demonstrate how the informationmight be used in planning andcontrolling activities (e.g.

benchmarking against similaractivities).

Discuss those factors that need to beconsidered when determining thecapacity and development potentialof a system.

3. Recording and processing methods

Demonstrate how the type ofbusiness entity will influence the

recording and processing methods. Discuss how IT developments (e.g.

unified corporate databases andnetwork technology) may influencemanagement accounting systems.

Discuss the difficulties associatedwith recording and processing dataof a qualitative nature.

4. Management reports

Discuss the principal controlsrequired in generating anddistributing internal information.

Discuss the procedures that may benecessary to ensure security ofhighly confidential information thatis not for external consumption.

Evaluate the output reports of aninformation system in the light ofbest practice and avoiding the

problem of information overload.D STRATEGIC PERFORMANCE

MEASUREMENT

1. Performance hierarchy

Discuss how the purpose, structureand content of a mission statementimpacts on business performance.

Discuss the ways in which high-level corporate performance

objectives are developed.

Ref:8

8

8

9


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(xii) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

Identify strategic objectives anddiscuss how they may beincorporated into the business plan.

Discuss how strategic objectives arecascaded down the organisation viathe formulation of subsidiaryperformance objectives.

Discuss social and ethicalobligations that should beconsidered in the pursuit ofcorporate performance objectives.

Explain the performance planninggap and evaluate alternativestrategies to fill that gap.

Apply critical success factoranalysis in developing performancemetrics from business objectives.

Identify and discuss thecharacteristics of operationalperformance.

Discuss the relative significance ofplanning as against controlling

activities at different levels in theperformance hierarchy.

2. Strategic performance measures inprivate sector

Demonstrate why the primaryobjective of financial performanceshould be primarily concerned withthe benefits to shareholders.

Justify the crucial objectives ofsurvival and business growth.

Discuss the appropriateness of, andapply different measures ofperformance, including:

Return on Capital Employed(ROCE)

Return on Investment (ROI) Earnings Per Share (EPS) Earnings Before Interest, Tax,

Depreciation and Amortisation

(EBITDA)

Ref:

10

Residual Income (RI) Net Present value (NPV) Internal rate of return and

modified internal Rate ofReturn (IRR, MIRR).

Discuss why indicators of liquidityand gearing need to considered inconjunction with profitability.

Compare and contrast short andlong run financial performance andthe resulting management issues.

Explore the traditional relationshipbetween profits and share valuewith the long-term profitexpectations of the stock marketand recent financial performance ofnew technology companies.

Assess the relative financialperformance of the organisationcompared to appropriatebenchmarks.

Discuss and apply Six Sigmameasures of performance.

3. Divisional performance and transferpricing issues

Describe, compute and evaluateperformance measures relevant in adivisionalised organisationstructure including ROI, RI andEconomic value added (EVA).

Discuss the need for separatemeasures in respect of managerialand divisional performance.

Discuss the circumstances in whicha transfer pricing policy may beneeded and discuss the necessarycriteria for its design.

Demonstrate and evaluate the useof alternative bases for transferpricing.

Ref:

11

11

12

12


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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xiii)

Explain and demonstrate issues thatrequire consideration when settingtransfer prices in multinational

companies.

4. Strategic performance measures innot-for-profit organisations

Highlight and discuss the potentialfor diversity in objectivesdepending on organisation type.

Discuss the need to achieveobjectives with limited funds thatmay not be controllable.

Identify and discuss ways in whichperformance may be judged in not-for profit organisations.

Discuss the difficulties inmeasuring outputs whenperformance is not judged in termsof money or an easily quantifiableobjective.

Discuss how the combination ofpolitics and the desire to measure

public sector performance mayresult in undesirable serviceoutcomes.

Assess value for money serviceprovision as a measure ofperformance in not-for-profitorganisations and the public sector.

5. Non-financial performanceindicators

Discuss the interaction of non-financial performance indicatorswith financial performanceindicators.

Discuss the implications of thegrowing emphasis on non-financialperformance indicators.

Discuss the significance of non-financial performance indicators inrelation to employees.

Ref:

12

13

14

Identify and discuss the significanceof non-financial performanceindicators in relation to

product/service quality (e.g.customer satisfaction reports, repeatbusiness ratings, customer loyalty,access and availability).

Discuss the difficulties ininterpreting data on qualitativeissues.

Discuss the significance of brandawareness and company profileand their potential impact on

business performance.

6. The role of quality in managementinformation and performancemeasurement systems

Discuss and evaluate theapplication of Japanese businesspractices and managementaccounting techniques, including:

Kaizen costing, Target costing, Just-in-time, and Total Quality Management.

Discriminate between quality,quality assurance, quality controland quality management.

Assess the relationship of qualitymanagement to the performancemanagement strategy of an

organisation. Advise on the structure and

benefits of quality managementsystems and quality certification.

Justify the need and assess thecharacteristics of quality inmanagement information systems.

Ref:

14


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7. Performance measurement andstrategic Human ResourceManagement issues

Explain how the effectiverecruitment, management andmotivation of people is necessaryfor enabling strategic andoperational success.

Discuss the judgemental anddevelopmental roles of assessmentand appraisal and their role inimproving business performance.

Advise on the relationship ofperformance management to

performance measurement(performance rating) and determinethe implications of performancemeasurement to quality initiativesand process redesign.

8. Performance measurement and thereward systems

Explore the meaning and scope ofreward systems.

Discuss and evaluate differentmethods of reward practices.

Explore the principles and difficultyof aligning reward practices withstrategy.

Advise on the relationship ofreward management to qualityinitiatives, process re-design andharnessing of e-businessopportunities.

Assess the potential beneficial andadverse consequences of linkingreward schemes to performancemeasurement, for example, how itcan affect the risk appetite ofemployees.

9 Other behaviour aspects ofperformance measurement

Discuss the accountability issuesthat might arise from performance

measurement systems.

Ref:15

15

15

Evaluate the ways in whichperformance measurementssystems may send the wrong

signals and result in undesirablebusiness consequences.

Demonstrate how managementstyle needs to be considered whendesigning an effective performancemeasurement system.

E PERFORMANCE EVALUATION

AND CORPORATE FAILURE

1. Alternative views of performance

measurement and management Evaluate the balanced scorecard

approach as a way in which toimprove the range and linkagebetween performance measures.

Evaluate the performancepyramid as a way in which to linkstrategy, operations andperformance.

Evaluate the work of Fitzgerald andMoon that considers performancemeasurement in business servicesusing building blocks fordimensions, standards andrewards.

Discuss and apply the PerformancePrism.

Discuss and evaluate theapplication of activity-basedmanagement.

Evaluate and apply the value-basedmanagement approaches toperformance management.

2. Strategic performance issues incomplex business structures

Evaluate the use and theapplication of strategic models inassessing the business performanceof an entity, such as Ansoff, Boston

Consulting Group and Porter.

Ref:

16

17


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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xv)

Discuss the problems encounteredin planning, controlling andmeasuring performance levels (e.g.

productivity, profitability, qualityand service levels) in complexbusiness structures.

Discuss the impact on performancemanagement of the use of businessmodels involving strategicalliances, joint ventures andcomplex supply chain structures.

3. Predicting and preventing corporatefailure

Assess the potential likelihood ofcorporate failure, utilisingquantitative and qualitativeperformance measures.

Assess and critique quantitativeand qualitative corporate failureprediction models.

Identify and discuss performanceimprovement strategies that may be

adopted in order to preventcorporate failure.

Discuss how long-term survivalnecessitates consideration of life-cycle issues.

Identify and discuss operationalchanges to performancemanagement systems required toimplement the performanceimprovement strategies.

Ref:

17

F. CURRENT DEVELOPMENTSAND EMERGING ISSUES INPERFORMANCE MANAGEMENT

1. Current developments inmanagement accountingtechniques

Discuss the ways through whichmanagement accountingpractitioners are made aware ofnew techniques and how theyevaluate them.

Discuss, evaluate and applyenvironmental managementaccounting.

Discuss the use of benchmarking inpublic sector performance (leaguetables) and its effects on operationaland strategic management andclient behaviour.

Discuss the issues surrounding theuse of targets in public sectororganisations.

2. Current issues and trends in

performance management Assess the changing role of the

management accountant in todaysbusiness environment as outlinedby Burns and Scapens.

Discuss contemporary issues inperformance management.

Discuss how changingorganisations structure, cultureand strategy will influence the

adoption of new performancemeasurement methods andtechniques.

Ref:

18

18


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SESSION 00 EXAM TECHNIQUE

(xvi) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

EXAM TECHNIQUE

Reading and planning time

The following is the suggested approach to the reading and planning time for paper P5.

Read the requirements of all parts of all questions. Decide which order you will do the questions in. This also means deciding which of the

Section B questions to do.

Plan you time. Remember you have to allocate 1.8 marks of exam time to each markavailable. On the front page of your question paper, write down the time that you willstart each question.

With any remaining time left, start to read the scenario from one of the long Section Aquestions, and start to plan. It is unlikely you will have time to plan it completelyduring reading and planning time.

Overall exam strategy

For most candidates, it is probably best to do the two Section A questions first, while you arerelatively fresh. If you suffer badly from exam nerves however, you may wish to do yourbest question from Section B first, to get you settled into the exam. At any rate, you are notadvised under any circumstances to do the Section A questions last.

Do stick to your time allocation, and do attempt all questions. Even if a question looks

difficult, there will always be easy marks.

Remember that in P5, the examiner is looking for you to apply your knowledge to real lifescenarios and not just to regurgitate what is in your text book. Do refer to the case scenariosin your answers.

Section A questions

Section A will be scenario type questions. The examiner has said that there will be a lot ofreading required.

During the planning time

Briefly read the initial paragraphs to gain a broad understanding of the scenario. Read the requirements of all parts of the question. Read through the scenario briefly to get a quick understanding of the case. Think about what is required. What do you need to do? Read the scenario more slowly. This time underline key information, make any relevant

notes and reference to the relevant parts of the question.


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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xvii)

For numerical parts of the question, think about your route to get to the answer. Whatcalculations will you perform, how will your workings be laid out. It there a simplerway? The current P5 examiner does not generally require too much calculationhowever.

Ensure that you have incorporated hints and facts from the scenario, particularly inwritten questions. Remember, this examiner does not normally provide superfluousinformation in his scenarios. If information is provided, it is there for a reason!

Section B Numerical questions

Before starting a computation, picture your route. Do this by jotting down the steps youare going to take and imagining the layout of your answer.

Set up a pro-forma structure to your answer before working the numbers.

Use a columnar layout if appropriate. This helps to avoid mistakes and is easier for themarker to follow.

Include all your workings and cross-reference them to the face of your answer. A clear approach and workings will help earn marks even if you make an arithmetic

mistake.

If you do spot a mistake in your answer, it is not worthwhile spending time amendingthe consequent effects of it. The marker of your script will not punish you for errorscaused by an earlier mistake.

Dont ignore marks for written recommendations or comments based upon yourcomputation. These are easy marks to gain.

If you could not complete the calculations required for comment then assume an answerto the calculations. As long as your comments are consistent with your assumedanswer you can still pick up all the marks for the comments.

Written questions

Planning

Read the requirements carefully at least twice to identify exactly how many points you arebeing asked to address.

Jot down relevant thoughts on your plan

Give your plan a structure which you will follow when you write up the answer.


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(xviii) 2012 DeVry/Becker Educational Development Corp. All rights reserved.

Presentation

Use headings, indentation and bullet points to give your answer structure and to make itmore digestible for the marker.

Use short paragraphs for each point that you are making.

Use bullet points where this seems appropriate.

Separate paragraphs by leaving at least one line of space between each one.


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SESSION 01 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING

2012 DeVry/Becker Educational Development Corp. All rights reserved. 0101

OVERVIEW

Objective

To introduce strategic management accounting.

PLANNING ANDCONTROL AT

DIFFERENT LEVELS

Role of corporate planning Overall planning framework External analysis Internal analysis Setting objectives Gap analysis Selection of strategies Strategic control

BENCHMARKING

CORPORATE

PLANNING &

STRATEGY

SWOT

ANALYSIS

Anthonys model

MULTINATIONAL

COMPANIES

Role of management accounting

Different types of organisation Internal and external analysis Benefits

STRATEGIC

PERFORMANCE

MANAGEMENT

POTENTIAL

CONFLICTS

Formal approach to strategic planning Reasons for conflict Potential solutions to the conflict

Management accounting Traditional management accounting Strategic management accounting Strategic management accounting tools

Internally set standards Types of benchmarking Stages Benefits of benchmarking Difficulties


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0102 2012 DeVry/Becker Educational Development Corp. All rights reserved.

1 STRATEGIC PERFORMANCE MANAGEMENT

1.1 Management accounting

Management accounting is concerned with the provision of information to enable

management to:

formulate policies; plan and control activities (including safeguarding assets); make decisions on alternative courses of action.Paper P5Advanced Performance Management is an advanced management accounting paper,which looks at the nature of management accounting and discusses whether or not thatinformation helps organisations to improve their performance. Performance managementinvolves designing systems for measuring the performance of organisations and the peoplewho work in those organisations. Performance is measured based on how well the

organisation is meeting its strategic objectives. The paper also looks at the latestdevelopments in management accounting.

1.2 Traditional management accounting

1.2.1 Meaning of traditional management accounting

Traditional management accounting includes areas such as:

Cost accounting; Budgeting; Variance analysis.Many of these techniques were developed in the late nineteenth century.

Commentary

You should already be familiar with traditional management accounting techniquesfrom earlier ACCA studies.

1.2.2 Lost relevance of traditional management accounting techniques

In the latter part of the twentieth century, many management writers argued thatmanagement accounting had lost its relevance. In particular, it was criticised for being tooinwardly focused. As the business world in which organisations exist has becomeincreasingly competitive and dynamic, it is essential for managers to focus on both internaland external factors.


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1.3 Strategic management accounting (Strategic performance management)

Since the 1980s management writers have proposed that management accounting shouldbecome broader in focus, and more strategic in nature. The term Strategic managementaccounting or Strategic performance management has been widely used since then to

refer to an extended role of management accountants. There is no universally accepteddefinition of the scope of strategic management accounting the term means different thingsto different writers. In general terms it is usually taken to mean:

The provision of information to support strategic planning and decision making inorganisations;

The provision of information that is external as well as internal; The use of non-financial as well as financial information;

The provision of information to support the competitive advantages of an organisation.

1.4 Some strategic management accounting tools

The following tools are examples of strategic management accounting:

The use of activity based costing and activity based management; Analysis of competitors using tools such as Benchmarking; Value chain analysis to gain competitive advantage.These are covered in later sessions.

2 CORPORATE PLANNING & STRATEGY

2.1 Role of corporate planning

Corporate planning involves formulating an organisations strategy, and converting this intoshorter term objectives, possibly by way of a formal plan. Targets may then be set, and theperformance of an organisation is measured against these targets. PerformanceManagement is all about defining the organisations strategy, and measuring how theorganisation is performing in relation to achieving its strategy.


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2.2 Overall planning framework

The following basic model of financial planning demonstrates how corporate objectives maybe formulated, and strategies developed to achieve these objectives.

EXTERNALANALYSIS

INTERNALANALYSIS

POSITIONANALYSIS

(SWOT)

MISSION,STAKEHOLDER

OBJECTIVES,SPECIFIC

OBJECTIVES

GAP

OVERALLSTRATEGY

INTERNALSTRATEGY

INVESTMENTSTRATEGY

FINANCINGSTRATEGY

This approach to planning is outward looking, since it considers the external as well as theinternal environment and enables realistic objectives to be set and the development ofstrategies which follow logically from the current position.


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2.3 External analysis

This requires a review of environmental influences on the organisation such as: Political situation; Legal framework pollution controls; Economic factors interest rates, exchange controls; Socio-cultural factors demography of the market; Technology new production processes; Competitive environment new entrant to the market, substitute products, etc.

This analysis should reveal external opportunities and threats. External analysis is coveredin more detail in Session 5.

2.4 Internal analysis

Looking at the organisations past and present activities and resources:

Products; Organisation structure; Systems and processes; Marketing; Distribution; Finance; Research and development; Use of new technology.

This analysis should reveal the organisations internal strengths and weaknesses.

2.5 Setting objectives

Having analysed the external environment, the management will then clarify the objectivesof the organisation.

It is common for objectives to be given a hierarchy. Higher level objectives, such as theMission Statement, are broad statements which deal with the overall aims of theorganisation. Moving down the hierarchy, the objectives become more specific.

Mission

Main

Supporting


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2.5.1 Main objectives

These can be mission statements or statements of intent to particular stakeholders (e.g.shareholders or employees).

2.5.2 Supporting objectives

These convert the main objectives into a series of targets for the business. These typicallyinclude profit or sales targets for immediate implementation. Sub-objectives can be passedfurther and further down the organisation resulting in short-term objectives for particulardepartments, such as reducing costs by a given percentage or signing up a particular level ofcustomers each month.

Illustration 1

Mission statement To increase the wealth of shareholders by maintaining our

position as the leading provider in the industry.

Main objectives to maintain the satisfaction of all customers.

Specific objectives customer returns must account for less than 2% by valueof products sold.

This hierarchy of objectives is sometimes referred to as the performance hierarchy and isdiscussed in more detail in Session 8.

2.6 Gap analysis

Gap analysis involves comparing the objectives of the business (where we would like to be)with what the business is achieving at the moment. Gap analysis could for example focus onthe gap between desired and actual market share, desired or actual revenue, or desired oractual profits.

Gap analysis is discussed in more detail in Session 8.

2.7 Selection of strategies

Management must make strategic choices. These determine how the organisation will go

about meeting its objectives.

2.7.2 Internal strategies

These focus on what the organisation needs to be good at internally to succeed. Forexample, a low cost airline develops strategies to save costs, such as reducing parking timeat airports, and using lower cost airports.

2.7.3 Investment strategies

These look at the whole area of what to invest in. This may include decisions such as

whether to expand by buying up competitors (mergers and acquisitions) or to groworganically. It also covers methods used for investment appraisal.


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2.7.4 Financing strategy

This looks at how to finance the organisation. Typical decisions include the appropriate mixof equity and debt and dividend strategies. (Such strategies are covered in paper F9Financial Management. )

2.8 Strategic control

Having set the corporate objectives, senior management will be involved in controlling theorganisation.

Definition

Control is the process of ensuring that a firms activities conform to its planand that its objectives are achieved.

Performance management focuses on designing systems for measuring the performance ofan organisation. Performance measures are developed, and progress is continuallymonitored by comparing actual results against targets for the performance measures.Performance measures are used at all levels of the organisation.

Strategic control involves ensuring that the organisation in on track to meet its long termstrategic objectives. A successful system of strategic control should therefore:

Focus attention on what matters in the long term. Identify the drivers of success. Many businesses identify critical success factors, and use

key performance indicators to measure their progress in meeting these.

Include reward schemes that are based on achieving the critical success factors.Definition

Critical success factors are the limited number of areas where things must goright if the organisation is to flourish.

3 PLANNING AND CONTROL AT DIFFERENT LEVELS

3.1 Anthonys model

Robert Anthony described three levels of management within an organisation:

Strategic involved in setting goals and objectives for the organisation over the longterm.

Tactical management involved in management control. This means ensuringresources are obtained and used effectively and efficiently in accomplishing theobjectives of the organisation.

Operational management ensuring that day to day tasks are carried out.


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Strategic

Tactical

Operational

Planninginfo

Controlinfo

A comparison of the three levels of management is given below:

3.1.1 Strategic planning

Deciding which products or markets to be in. Investment decisions. Planning for environmental changes. Identifying the competitive advantage of the organisation. Longer term timescale could be years.3.1.2 Tactical planning

Implementing the strategic decisions, often via a long term plan. Preparation of annual budgets, and comparison of actual results with budgets on a

monthly basis.

Recruitment of staff. Shorter time period for planning typically one year ahead. Use of both internal and external information.3.1.3 Operational planning

Routine planning (e.g. staff rotas). Programmed decisions (e.g. ordering inventory when inventory levels fall to re-order

levels).

Based on internal, transaction based information.3.1.4 Strategic control measures

Profits by business segment. External factors influencing the organisation. Present and potential market studies. Investment appraisal.3.1.5 Tactical control measures

Analysis of sales by product/customer/geographical location. Inventory levels. Cash flow projections.


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3.1.6 Operational control measures

Variances (e.g. materials and labour). Receivables/payable levels. Payroll details. Customer complaints. Output records.Example 1

Vacation Lodge runs a chain of three star hotels throughout the world. Thecompanys head office is in New York, where the executive and non-executivedirectors are based.

Each hotel has a management team headed by the general manager. The othermembers of the management team are the financial controller, the rooms

division manager, the food and beverage manager, the sales and marketingmanager and the head of security.

Each hotel has an executive chef, responsible for the restaurants. The executivechef reports to the food and beverage manager of the hotel.

Required:

Describe the types of plan that will be prepared by the directors, themanagement teams and the executive chef. For each plan, describe controlmeasures which can be used to see how well the plan is being achieved.

Solution

Plans Controls

Board of directors

Management team

Executive chef


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4 MULTINATIONAL COMPANIES

4.1 Role of management accounting

Management accounting is used by multinational companies to coordinate and integrate

their activities in different countries. Such coordination normally takes place through thesystems of budgeting, performance measurement and currency management.

Issues of particular importance include the following:

Currency management the volatility of exchange rates makes measuring theperformance of the various parts of the organisation more complex.

Managing relationships with host governments over areas such as tax breaks andsubsidies. Many management accounting systems measure the performance ofmanagers of foreign operations based on after tax profits rather than pre-tax.

Transfer pricing may be used as a method of transferring profits from high tax to lowertax states. This is covered in more detail in a later session.

4.2 Different types of multinational organisation

Porter suggests that multinationals may be classed into three types:

(1) The global firm an organisation that covers many different states, where the activitiescarried out in each state are interdependent. For example, some components may bemade in one country, some in another, and final assembly may take place in yet another

country.

(2) The multidomestic firm is made up of a number of subsidiaries in different countries,where the activities of one subsidiary are largely independent of others.

(3) Exporting firms tend to carry out most of their operations in the domestic market, andsell into foreign markets via agents.

The differences in the approach to management accounting in the global firm and themultidomestic firm can be summarised by the following table:


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Issue Global firm Multidomestic firm

Strategy To internationalise the valuechain

To balance risk throughportfolio management

Role of headquarters To develop and coordinatesubsidiaries in an integratedeffort. Coordination ofsubsidiaries is strong.

To enhance the managementof financial resources.Corporate coordination ofsubsidiaries is weak.

Role of subsidiary To carry out and support adetailed strategy developedat headquarters.

To develop its own strategytowards market andproduction.

Role of budgeting To integrate activities across

subsidiaries with anemphasis on products andmarkets

To establish targets for each

individual subsidiary withan emphasis onaccountability

Performance evaluation Many and diverse financialand non-financialperformance measuresoriented towards productsand markets.

Relatively few, butaggregated financialperformance measuresoriented towards individualorganisational entities.

Source: Management Accounting in Global Firms by Jan Mouritsen.

5 POTENTIAL CONFLICTS

5.1 Formal approach to strategic planning

The strategic planning model described above assumes a top down approach to strategicplanning, whereby a central board of directors sets the strategy, the rest of the organisationis expected to achieve it. Where local decisions are being made by managers (e.g. in the caseof a decentralised organisation) there is a risk that the decisions made locally may not beconsistent with the strategy.

5.2 Reasons for conflict

There are several reasons why conflicts arise between strategic plans and short-term localdecisions:

8 Managers incentive schemes may not be aligned with the strategy of the organisation.For example, managers bonuses may depend on the current years profits which couldbe increased at the expense of longer-term strategic objectives, such as quality.

8 Local managers may have better knowledge of local opportunities than the directorswho set the strategy.


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8 Long term plans are prepared long before the period to which they apply. Actualconditions may be quite different.

8 Local managers may feel that the formal strategic plan stifles their own creativity orideas it may not be flexible enough to allow unplanned opportunities to be adopted.

5.3 Potential solutions to the conflict

A parenting style may provide the solution to the conflict between strategic planning andlocal decision making. Under such an approach, business units may formulate their ownstrategies, while head office may set broader targets for the business units to achieve.

6 SWOT ANALYSIS

6.1 Internal and external analysis

In the corporate planning model described in section 2 above, one of the first things themanagement do when planning is to perform analysis of the internal and externalenvironment. One tool which is commonly used for such an exercise is SWOT analysis.

Definition

SWOT analysis is a critical assessment of an organisations Strengths andWeaknesses (identified from internal analysis) and Opportunities and Threats(identified from external analysis) in order to establish its condition prior to thepreparation of any long-term plans.

By identifying the companys strengths and weaknesses during the planning process,management can ensure that they plan to focus on performing those activities which thecompany is good at, while avoiding those areas where the company lacks the relevantskills or resources to compete effectively.

Opportunities represent business opportunities that the company may wish to exploit,provided that it has the relevant skills. Thus it attempts to match the companysstrengths with the opportunities available.

Threats represent threats from outside. This could include a variety of things competitors, new government regulations which threaten the industry, changes in socialattitudes and so on.

Swot analysis is often performed using a table with four quadrants. The strengths,weaknesses, opportunities and threats are then listed in the appropriate quadrants.


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Example 2

Brilliant Airlines is the national airline of a small country in the EuropeanUnion. It is one of the oldest and most respected airlines in the world.

The company is based at Schiphoven airport; one of the busiest airports in theworld. This, coupled with alliances that the company has made with otherairlines, means that the airline can take advantage of passengers from otherless well connected airports, which connect at Schiphoven for longer flights.

Recently the company has been suffering stiff competition on certain routesfrom low cost airlines, who offer a no frills service. Due to their lower costbase, these low cost airlines are able to offer passengers much lower fares thanBrilliant Airlines charges.

The European Union is now introducing a tax on fuel in an attempt to reducethe impact of greenhouse gasses caused by airlines. This will significantlyincrease the costs of the airline.

Required:

Based on the information provided above, perform a SWOT analysis onBrilliant Airlines, and suggest any opportunities that the airline may focus on.

Solution

Strengths Weaknesses

Opportunities Threats

6.2 Benefits of SWOT analysis

9 The focus on internal strengths and weaknesses ensures that strategic decisions aretaken which are appropriate for the organisation.

9It focuses the attention of management on external factors (threats and opportunities).Thus management can plan how to deal with changes, such as a decline in the market.


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7 BENCHMARKING

7.1 Problems with internally set standards

One of the core tools of traditional management accounting is variance analysis, which

involves the setting of a standard cost. One potential problem with this is that setting thestandard normally involves considering what was used in earlier periods and notconsidering what other organisations are achieving so the standards set are notchallenging enough.

Benchmarking is a tool which involves comparison of the performance of an organisationagainst other organisations. The focus is therefore external.

Definition

Benchmarking (also best practice benchmarking or process benchmarking)is a process used in management and particularly strategic management, inwhich organizations evaluate various aspects of their processes in relation tobest practice, usually within their own sector. This then allows organizationsto develop plans on how to adopt such best practice, usually with the aim ofincreasing some aspect of performance.

7.2 Types of benchmarking

Competitive benchmarking comparing performance with competitors. Can bedifficult to obtain information about competitors however.

Commentary

This was pioneered by Xerox when Japanese competitors sold copiers into US at lessthan Xeroxs manufacturing cost costing Xerox half their market share.

Internal benchmarking comparing one operating unit or function with another withinthe same organisation in order to establish best practice.

Process benchmarking focusing on qualitative information around specific businessprocesses.


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7.3 Stages

(1) Planning and organisation (e.g. setting up a steering group and setting out aims andobjectives).

(2) Identification of key internal processes for analysis:

Practices steps in a process;Metrics measures of times and outcomes (e.g. cost, quality, speed, reliability).

(3) Researching potential partners (those perceived to be the best). Collecting informationand investigating metrics for comparison.

(4) Making agreements and developing plans for exchange visits. Formulating a commonprogram for internal data collection and its presentation and analysis.

(5) Partner site visits by benchmarking teams collect dataand ensure comparability.

(6) Analysing data and developing plans for improvements.

(7) Implementation and monitoring.

Illustration 2

An organisation wishes to benchmark the effectiveness of its finance function.It may identify the following metrics that it wishes to use. These would thenbe compared against industry best practice:

Cost of finance function as a percentage of revenue; Cycle time time taken (days) to perform annual close; Staff productivity (e.g. number of invoices processed per member of staff); Error rate (e.g. percentage of payroll processing errors).7.4 Benefits of benchmarking

9 Provides focus for change within an organisation.9 Identifies opportunities for improvement.9 Helps to establish best practice.9 Should lead to long term improvement in profits.7.5 Difficulties of benchmarking

8 Competitors will not wish to share information.8 Complexity of the information collected too much data can be difficult to interpret.8 Short term improvements may have unintended longer term consequences.8 Quantitative information provided may miss important qualitative.8 The time taken to implement the results of benchmarking may mean that theorganisation continues to lag behind the competitor.


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Key points

Strategic management accounting is a broad term, encompassing anapproach to management accounting that is more externally focused, toassist management in formulating and implementing strategy.

Strategic planning may follow the modern approach which involvesanalysing the organisations strengths and weaknesses, and then clarifyingthe objectives of the organisation, before deciding on the strategic actionsrequired.

Strategic control means monitoring the performance of the organisation toensure that it will meet its long term strategic objectives.

Organisational planning takes place at different levels. Anthonys modeldefines three levels of planning Strategic, Tactical and Operational.

Strategic management accounting is more challenging in multinationalorganisations. The objectives of control differ depending on theorganisational structure of the multinational.

There is always scope for conflict between strategic plans developed bythe board of directors and the short term decisions made by localmanagers. Organisations should identify ways to remove this conflict,such as adopting a parenting style.

SWOT analysis is a useful tool in developing the objectives of anorganisation.Benchmarking provides organisations with a more external focus when

setting standards of performance.


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FOCUS

You should now be able to:

explain the role of strategic performance management in strategic planning and control; discuss the role of corporate planning in clarifying corporate objectives, making

strategic decisions and checking progress towards the objectives;

compare planning and control between the strategic and operational levels within abusiness entity;

assess the use of strategic management accounting in the context of multinationalcompanies;

discuss the scope for potential conflict between strategic business plans and short termlocalised decisions;

evaluate how SWOT analysis may assist in the performance management process; evaluate the methods of benchmarking performance.


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EXAMPLE SOLUTIONS

Solution 1 Planning and control

The following is not an exhaustive list of the plans and controls any other reasonable plans

and controls are also relevant.

Plans ControlsBoard of directors Five year financial plan Actual profits v plan

New hotel openings monitoring progress

Management team Annual budget Compare actual against budgetOccupancy rates

Staff Headcount Actual v plan

Executive chef Menus Food wasted

Staff rotas Staff attendance

Solution 2 SWOT analysis for Brilliant Airlines

Strengths

The National Airline flag carrier

Good reputation particularly amongbusiness passengers

Good location at major Airport

Alliances with other airlines

Weaknesses

Higher cost base

Opportunities

Focus on business passengers lessprice sensitive

Threats

Competition from low cost airlines

Additional fuel taxes

Commentary

Questions such as these are judgemental by nature; there is no single right answer(particularly as regards to the opportunities). In the exam, the examiner awards marks

for sensible suggestions.


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SESSION 02 PERFORMANCE MANAGEMENT AND CONTROL OF THE ORGANISATION


OVERVIEW

Objective

To appraise alternative methods for budgeting for control.

Criticisms of traditional budgeting Beyond Budgeting Model

BUDGETING INNOT-FOR-PROFITORGANISATIONS

Top down v bottom up Fixed v flexible Rolling budgets Incremental budgeting Zero based budgeting (ZBB) Activity based budgeting (ABB)

How budgeting may differ Traditional approach Planning, programming budgeting

systems (PPBS)

ALTERNATIVEBUDGETING

MODELS

BEYONDBUDGETING


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1 ALTERNATIVE BUDGETING MODELS

1.1 Top down v bottom up budgeting

Top down budgeting is where budgets are prepared centrally, usually by senior

management. These are then imposed on more junior managers.

Bottom up budgeting means that managers prepare their own budgets initially. These arethen reviewed by the finance department some negotiation may take place before the finalbudget is achieved.

Example 1

State the advantages of top down budgeting and the advantages of bottom upbudgeting.

1.1.1 McGregors theories of human behaviour

McGregor suggests that the circumstances in which top down or bottom up budgetingwould be more appropriate depends on the nature of the employees. The two types ofemployees are the Theory X and Theory Y employees:

Theory X people dislike work; people dislike responsibility; they are only motivated by money; they must be

toldwhat to do.

Theory Y people seek responsibility; they want toparticipate in decision making.

The type of employee working for an organisation therefore has implications for thebudgetary process.

Employee type X Y

Motivated by Money Many factors

Does participationincrease motivation? No Yes

Management style Authoritarian Participativeapproach approach

Budgeting style TOP DOWN BOTTOM UP


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Features Senior management preparebudgets;

Imposed on juniormanagement;

Quicker than bottom upapproach.

Junior management preparebudgets;

Senior management review toensure consistent with

organisation objectives;

But risk of budget bias/slack.

1.2 Fixed v flexible budgets

At the end of the period, actual results are compared to the budget, and action taken toremedy any deviations from the budget in future periods. The problem arises that if thebudget is prepared at one activity level, and the actual activity is very different, then thecomparison becomes less meaningful, as it is difficult to see what deviations from the

budget are due to the different level of activity, and what deviations are due to other factors.The first three approaches to budgeting relate to how the budgets are adjusted to takeaccount of actual activity levels prior to the comparison of budgeted and actual amounts.

1.2.1 Fixed budgets

A fixed budget is prepared at the beginning of the period based on the expected activitylevel (sales units, production units etc.) No adjustment is made to this budget at the end ofthe year when comparing actual performance against the budget. This means that thebudgeted activity levels may be very different from the actual activity levels, makingcomparison difficult.

1.2.2 Flexible budgets

When the budget is prepared, several versions of the budget are prepared. So a budget maybe prepared, for example, for 12,000, 14,000 and 16,000 units. At the end of the year thebudget that is closest to the actual activity level is used for the comparison of actual resultsagainst the budget.

Such an approach requires knowledge of cost behaviour which costs are fixed, so will notvary with output, and which are variable.

1.2.3 Flexed budgets

At the end of the year, prior to comparing the actual figures against the budget, the budgetis recalculated (flexed) using the original budget assumptions, but the actual activity levels.This means that the comparison is more valid.


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Illustration 1

Original budget

$000 $000

Sales (50,000 items @ $100) 5,000

Production (55,000 units)Materials (55,000 40) 2,200Labour (55,000 3) 165Variable overheads (55,000 x 9) 495Fixed overheads (55,000 x 15) 825

_____

Budgeted cost of production 3,685

Less: Closing inventory (5,000 @ $67) (335)_____

Standard cost of goods sold 3,350_____

Budgeted profit (50,000 @ $33) 1,650

_____

Actual sales were 53,000 units and production was 56,000 units. The flexed budgetwould be calculated as follows:

Flexed budget$000 $000

Sales 53,000

$100 5,300

Production costsMaterials 56,000 $40 2,240Labour 56,000 $3 168Variable overheads 56,000 $9 504Fixed overheads 825Less: Closing inventory (201)

______

Cost of goods sold 3,536______

Profit 1,764______

1.2.4 Advantages of flexed and flexible budgets

9 Easier comparison of actual results against the budget since like is being compared withlike.

9 During the planning stage, management has better knowledge of cost behaviour, andtherefore what impact changes in output will have on total costs.


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1.2.5 Disadvantages of flexed and flexible budgets

8 In the modern business world, many costs are fixed so flexible and flexed budgetsmay add little value.

8 Difficulty of identifying variable and fixed costs.Example 2

Good Trip is a travel agency. It employs a team of five staff an accountant,three sales staff and a manager. The agency does not organise holidaysdirectly, but acts as agent for big package holiday companies. The companyreceives a commission on each booking that is made.

Required:

Discuss whether fixed or flexible budgeting would be more appropriate forGood Trip.

1.3 Rolling budgets (Rolling forecasts)

1.3.1 Weaknesses of traditional periodic budgeting

8 Traditional periodic budgets are prepared in advance for the full budget period(typically one year). The problem with this approach is that the budget itself maybecome outdated very quickly due to changes in the external environment.

In response to this weakness, many organisations prefer to use rolling budgets.Definition

A rolling budget is a system of budgeting where the budget is continuouslyupdated. The budget horizon (typically one year) is kept constant by addinganother month (or quarter) to the end of the budgeted period as each month(or quarter) expires.

Illustration 2

A budget is prepared for the year 2010.

At the end of January 2010, the actual performance for the month of January iscompared against the budget. Based on this comparison, it may be decidedthat the budgets for the period 1 Feb to 31 Dec 2010 should be changed toreflect changes in external factors. Once this has been done, a budget is alsoprepared for January 2011. The new budget therefore covers the period from 1February 2010 to 31 January 2011.


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1.3.2 Advantages of rolling budgets

9 The budget is always updated to reflect external changes. It is therefore more relevantand more valid for comparison against actual performance.

9 There will always be a budget for the next 12 months. This can be useful for planningthings such as cash flows.9 Managers will be more motivated as the budget is more realistic, since it will be

updated to take account of changes that occur that are outside of their control.

1.3.3 Disadvantages of rolling budgets

8 Time consuming.8 Budgets may be changed to hide operational inefficiencies.8 Not necessary in a stable environment.Example 3

Betterbuys is a food retailer that runs a supermarket in northern England. Peardevelops portable communication devices and music players to the top layer ofthe market. Pears products have short lifecycle due to the competitive natureof the market.

Required:

Discuss whether rolling budgets would be appropriate for each of the twoorganisations.

1.4 Incremental budgeting

Starts with previous periods budget or actual results. Add/subtract an incremental amount to cover:

Any known changes to the business; Inflation.

Only the increment needs to be justified. May be appropriate for stable business with good cost control.1.4.1 Advantages of incremental budgeting

9 Easy and quick to prepare the budgets.


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1.4.2 Disadvantages of incremental budgeting

8 Unnecessary costs will remain in the budget because they were in the previous yearsbudget. Inefficiencies will therefore be compounded.

8 Does not encourage a detailed examination of where efficiencies can be identified.8 Budgeted expenditure is not related to the activities that the organisation wishes to

perform.

1.5 Zero based budgeting (ZBB)

Commentary

This was developed in 1960s by Federal Government managers in the US.

1.5.1 Basic features

Zero based budgeting is an attempt to overcome the weaknesses in incremental budgetingin particular, the criticism that costs will be included in a budget because they were inprevious years budgets. Zero based budgeting requires managers to plan what projectsthey wish to do, and base the budget around these.

Starts with assumption that the budget for next period is zero. Budget holders identify what programmes their department wishes to perform in the

next year.

Budget holders prepare a decision package for each program which includes: Goal of the programme; Level of funding required and benefits; Consequences to the company of the department not performing its function.

Senior management (usually a budget committee) decide which decision packages toaccept based on predetermined criteria.

Resources allocated to departments according to ranking.1.5.2 Advantages of zero based budgeting

9 Should reduce budgetary slack as costs must be justified based on the activities theyrelate to.

9 Useful for discretionary spending and support activities such as advertising andresearch and development where management can choose how much to spend on aparticular item.

9 Resources will be allocated to the programmes that best achieve the objectives of theorganisation.


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1.5.3 Disadvantages of zero based budgeting

8 Too costly and time consuming this is why it has never achieved the popularity thatits proponents expected.

8 Not appropriate for non-discretionary expenditure such as costs of production as thesedepend on quantities of output.8 Budget holders, staff and unions may feel threatened that they have to justify their

existence.

8 The ranking and selection of packages may be subjective.Commentary

Many organisations have used a partial version of zero based budgeting where zerobased budgeting is used in some departments that do discretionary type activities, suchas marketing, but not used throughout the organisations. Other organisations haveused zero based budgeting as a one off exercise to identify potential cost savingsbefore returning to more traditional incremental types of budgeting in future periods.

1.6 Activity based budgeting (ABB)

1.6.1 Principles of activity based budgeting

Activity based costing (ABC) is assumed knowledge from paper F5 Performance Management.

Activity based budgeting follows the principles of ABC in reverse. Having decided how

many units to produce and sell, the organisation then needs to define the cost of theactivities required t

Documents

Performance Management Study System