PM Performance Management

A. Management information systems and data analytics

Information systems support the work of an organisation by collecting, storing, processing and reporting data. A transaction processing system records day to day events such as sales. A management information system turns this data into reports for middle managers. A decision support system helps managers to analyse options, and an executive information system gives senior managers summaries and trends. An enterprise resource planning (ERP) system links the main functions of the business into one database. The different levels need different information: operational managers need detailed and frequent information, tactical managers need summaries and comparisons, and strategic managers need broad, forward-looking and external information.

The benefits of an information system include faster and better decisions, better control, less duplication and improved customer service. The costs include hardware and software, installation, training, running costs, and the cost of changing processes, and there are risks such as security failures, disruption during changeover and resistance from staff. The internet, an intranet (a private network inside the organisation), an extranet (a network shared with selected outside parties) and wireless networks support communication, access to information and remote working. Information needs to be controlled, and good controls include access rights, backups, authorisation and checks on input and processing.

Big data is data of high volume, velocity, variety, veracity and value. The big data pyramid shows data at the base, then information, knowledge and wisdom at the top, as data is processed and interpreted. Data mining looks for patterns in large data sets, and data analytics uses these and other techniques to gain insights. The four types of analysis are descriptive (what happened), diagnostic (why it happened), predictive (what is likely to happen) and prescriptive (what should be done). Big data brings challenges and risks, including privacy and data protection, the cost and skill needed, poor data quality, and the danger of drawing wrong conclusions from correlations that have no real cause.

Key terms

• ERP system: An integrated system that links the main functions of an organisation through a shared database.
• Data mining: Searching large data sets for patterns and relationships.
• Prescriptive analytics: Analysis that recommends what action to take.

Study tip: For information system questions, link the type of system to the level of management it serves.

Practice questions for section A

B. Specialist cost and management accounting techniques

Activity-based costing (ABC) assigns overheads to products using the activities that cause the costs. The steps are to identify the major activities, group the costs into cost pools, identify a cost driver for each pool, calculate the cost per unit of the driver, and charge each product for the drivers it uses. ABC gives more accurate product costs than absorbing all overheads on one basis, such as labour hours, when overheads are a large part of cost and products consume activities in different ways. It is costly to set up, and some costs have no clear driver.

Target costing starts with the price the market will pay and subtracts the required profit margin to find the target cost, which the product must be designed to meet. If the current cost is higher, the gap is closed through value engineering and cost reduction. Life-cycle costing records the costs of a product over its whole life, from design and development to withdrawal, because many costs are committed at the design stage. It helps to price products so that all costs are recovered and to see that cutting spending on design may raise later costs.

Throughput accounting aims to maximise throughput, which is sales revenue less direct material cost, through the bottleneck resource. Labour and overheads are treated as fixed factory costs. The return per factory hour is throughput divided by the time on the bottleneck. The cost per factory hour is total factory cost divided by total bottleneck hours. The throughput accounting ratio is the return per factory hour divided by the cost per factory hour. A ratio above 1 means the product earns more than its cost of using the bottleneck, so a ratio below 1 is a warning sign. Products are ranked on the return per bottleneck hour.

Accounting for environmental and sustainability factors helps organisations to identify, measure and reduce environmental costs and to manage resources. Environmental management accounting techniques include life-cycle costing, input-output analysis (accounting for the flow of materials in and out, including waste), flow cost accounting (tracking the cost of material flows and waste through the process) and ABC. Many environmental costs are hidden in overheads, and the techniques aim to bring them out.

Worked figures

ABC: setup costs are $60,000 for 100 setups, a rate of $600 per setup. Inspection costs are $40,000 for 200 inspections, a rate of $200. A product that needs 30 setups and 50 inspections is charged 30 x 600 + 50 x 200 = $28,000. If 1,000 units are made, that is $28 a unit.

Throughput: product X sells for $100 with $40 of material and uses 2 bottleneck hours, so the return per hour is ($100 - $40) / 2 = $30. Total factory cost is $120,000 for 4,000 bottleneck hours, a cost of $30 an hour, so the ratio is 1.00. Product Y sells for $80 with $30 of material and uses 1 hour, so its return per hour is $50 and its ratio is 1.67.

Key terms

• Cost driver: The factor that causes the cost of an activity to change.
• Value engineering: Redesigning a product or process to reduce cost while keeping the features customers value.
• Throughput: Sales revenue less direct material cost.
• Bottleneck: The resource that limits output.

Study tip: Remember the order for target costing: price first, then profit, then the cost you are allowed.

Practice questions for section B

C. Decision-making techniques

Relevant cost analysis applies the same rules as in earlier papers: only future, incremental cash flows count. The opportunity cost of using a scarce resource is relevant. Sunk costs, committed costs, non-cash items and general overheads that do not change are ignored.

CVP analysis with more than one product uses a weighted average contribution based on the sales mix. Break-even units for the whole mix equal fixed costs divided by the average contribution per unit of the mix, and the units of each product follow the mix. The margin of safety is the percentage by which sales can fall before the break-even point. CVP assumes that costs and revenues are linear, that the sales mix is constant, and that there are no changes in inventory.

Limiting factors. With one scarce resource, rank products by contribution per unit of the resource. With two or more scarce resources, the best plan is found using linear programming, usually with a graph of the constraints. The feasible region is the area that satisfies all the constraints, and the optimum is at a corner point of that region. The shadow price of a resource is the increase in contribution from one more unit of the resource, and it is the maximum extra price worth paying for it.

Pricing decisions. Cost-plus pricing adds a margin to cost. It is simple but ignores demand. Demand-based approaches use the price elasticity of demand, which is the percentage change in quantity demanded divided by the percentage change in price. Demand is elastic if the absolute value is more than 1, so a price cut raises revenue. Profit is maximised where marginal revenue equals marginal cost. Market skimming sets a high price at first for new products and cuts it later. Market penetration sets a low price to gain share. Other tactics include premium pricing, loss leaders, price discrimination, bundling and dynamic pricing.

Make-or-buy decisions compare the relevant cost of making with the price of buying, taking account of spare capacity and what the capacity could earn elsewhere. Other short-term decisions include whether to shut down a product or division, whether to accept a special order, and whether to process further. The relevant costs are those that are avoidable, and non-financial factors, such as quality, reliability and supplier dependence, should also be considered.

Risk and uncertainty. Risk exists when probabilities can be assigned to outcomes and uncertainty when they cannot. Expected value weights each outcome by its probability, and it is suitable for repeated decisions and for risk-neutral decision makers. When probabilities are unknown, the maximax rule chooses the option with the best best-case result (optimistic), maximin chooses the option with the best worst-case result (cautious), and minimax regret chooses the option with the smallest largest regret (the regret is the loss from not choosing the best option for each outcome). Sensitivity analysis tests how far a variable can change before the decision changes. The value of perfect information is the expected value with perfect information less the expected value without it. Decision trees show the sequence of decisions and outcomes.

Worked figures

Multi-product CVP: A sells for $20 with variable costs of $12, and B sells for $30 with variable costs of $18. They sell in the ratio 2:1, so the average contribution per unit is (2 x 8 + 1 x 12) / 3 = $9.33. With fixed costs of $56,000, break-even is 6,000 units in total, which is 4,000 of A and 2,000 of B.

Risk: three plans have payoffs (high, medium, low demand) of A: 120, 80, 20; B: 90, 70, 50; C: 60, 60, 60. Maximax chooses A, maximin chooses C and minimax regret chooses B (largest regrets A 40, B 30, C 60). With probabilities 0.3, 0.5 and 0.2, expected values are A 80, B 72 and C 60, and the value of perfect information is 8.

Pricing: if demand is P = 100 - 0.02Q, then marginal revenue is 100 - 0.04Q. With a marginal cost of $20, marginal revenue equals marginal cost at Q = 2,000, and the price is $60. If a 4 percent price rise cuts demand by 10 percent, the elasticity is -10 / 4 = -2.5.

Key terms

• Shadow price: The extra contribution from one more unit of a scarce resource.
• Price elasticity of demand: The percentage change in quantity demanded for a percentage change in price.
• Maximin: A rule that chooses the option with the best worst outcome.
• Value of perfect information: The most worth paying for information that removes uncertainty.

Study tip: For decision rule questions, set the payoff table out first and then apply each rule step by step.

Practice questions for section C

D. Budgeting and control

Budgetary systems. Incremental budgeting adds or subtracts a percentage from last year's figures. It is simple but can carry forward inefficiency. Zero-based budgeting (ZBB) starts from nothing and requires every activity to be justified, which challenges spending but takes time. Rolling budgets are updated regularly, adding a new period as each one ends, which keeps the budget current. Activity-based budgeting links the budget to the activities that drive costs. Participative budgets involve those who must meet them, which improves commitment and information, while imposed budgets are faster but may demotivate. Beyond budgeting rejects fixed annual budgets in favour of flexible targets and continuous planning.

Analytical techniques in budgeting and forecasting include regression, time series analysis, and the learning curve. The learning curve describes how the time per unit falls as the number of units made doubles, and it is used to forecast labour costs for repetitive tasks. Expected values and sensitivity analysis can be used when forecasts are uncertain.

Standard costing. All the variances from MA are assumed knowledge: material price and usage, labour rate and efficiency, variable overhead expenditure and efficiency, fixed overhead expenditure, volume and sales variances. Where a business uses more than one material or labour type, the usage variance can be split into a mix variance and a yield variance. The mix variance shows the effect of using a different proportion of inputs than the standard, valued at standard prices. The yield variance shows the effect of getting more or less output than the standard from the total input. A favourable mix variance can come with an adverse yield variance if cheaper materials lower the output.

Sales mix and quantity variances. When several products are sold, the sales volume profit variance splits into a mix variance (selling a more or less profitable mix than budgeted) and a quantity variance (selling more or fewer units in total than budgeted, at the standard average profit).

Planning and operational variances. A traditional variance compares actual results with an original standard, which may be out of date. A planning variance is the difference between the original standard and a revised standard that reflects a change in conditions outside the manager's control, such as a market price rise, and an operational variance is the difference between the revised standard and the actual result. Operational variances show the manager's performance, and planning variances show the quality of the original plan. Ex-post standards make the comparison fairer, but it is hard to set a revised standard objectively.

Performance analysis uses variances to find causes and decide who is responsible. Variances are linked: a cheaper supplier may cause an adverse usage variance, and a rise in efficiency may need more costly materials. Possible actions include correcting the cause, changing the standard or accepting the variance.

Worked figures

Mix and yield: the standard mix is 60 percent of X at $2 and 40 percent of Y at $3, a standard cost of $2.40 per kg of input, and the standard yield is 90 percent. Actual input was 650 kg of X and 350 kg of Y (1,000 kg), and output was 855 kg. At the standard mix the 1,000 kg would be 600 kg of X and 400 kg of Y. Mix variance = (600 - 650) x 2 + (400 - 350) x 3 = $50 favourable. The standard input for 855 kg of output is 855 / 0.9 = 950 kg, so the yield variance = (950 - 1,000) x 2.40 = $120 adverse.

Planning and operational: the original standard price is $5 a kg, the revised (ex-post) standard is $5.50 and the actual price is $5.40 for 1,000 kg. The planning variance is (5.00 - 5.50) x 1,000 = $500 adverse and the operational variance is (5.50 - 5.40) x 1,000 = $100 favourable. Together they equal the traditional price variance of $400 adverse.

Key terms

• Zero-based budgeting: A budget built up from nothing, with every item justified.
• Rolling budget: A budget that is updated regularly by adding a new period.
• Planning variance: The difference between the original standard and a revised standard.
• Operational variance: The difference between the revised standard and the actual result.

Study tip: Mix and yield variances add up to the usage variance. Check your answers by adding them.

Practice questions for section D

E. Performance measurement and control

Performance in a private sector business is measured through financial indicators such as profit, return on capital employed, liquidity and efficiency ratios, and non-financial indicators such as quality, customer satisfaction and employee turnover. The balanced scorecard groups measures into financial, customer, internal business process, and innovation and learning perspectives. The building block model of Fitzgerald and Moon links dimensions (such as financial performance, competitiveness, quality and flexibility), standards and rewards. Public sector and not-for-profit organisations often cannot use profit, so value for money (economy, efficiency and effectiveness) is used, along with measures of quality and equity. Objectives are many and may conflict, outputs are hard to measure, and stakeholders have different views.

Divisional performance. Return on investment (ROI) is divisional profit divided by capital employed, and residual income (RI) is divisional profit less a charge for the capital employed at the required rate of return. ROI is a percentage that is easy to compare, but it may cause managers to reject projects that would earn above the cost of capital but below the division's current ROI. RI avoids this and encourages investments that earn more than the required rate, but it is an absolute amount, so it is harder to compare between divisions of different sizes. Controllable profit should be used to judge the manager and traceable profit to judge the division.

Transfer pricing sets the price at which divisions of a business trade with each other. The aims are to motivate managers, to help to judge performance fairly and to make decisions that are best for the whole group (goal congruence). The minimum transfer price for the selling division is the marginal cost plus the opportunity cost of the sale (which is the contribution lost from the other uses of the capacity, so it is zero if there is spare capacity). The maximum price for the buying division is the lower of the net marginal revenue from using the item and the price it could pay outside. Market price is usually best when there is a competitive market. Cost-based prices are simple, but they may give poor incentives. A dual price gives the seller and the buyer different prices, and negotiated prices are flexible but take time. In a multinational group, there are further issues: differences in tax rates, exchange rates and controls, import duties and the rules of tax authorities on arm's-length pricing.

Not-for-profit and public sector organisations have specific issues. Their aims are often social, so measures include the quality and reach of the service as well as cost. Many cannot set prices, and funding can depend on political decisions. League tables and targets can be useful, but they can also lead to distorted behaviour, such as concentrating only on the targets that are measured.

Worked figures

A division earns profit of $180,000 on capital employed of $1,000,000, and the required return is 12 percent. ROI = 18%. RI = 180,000 - 12% x 1,000,000 = $60,000.

Transfer price: the marginal cost of an intermediate product is $14 and it sells outside for $22. If the selling division is at full capacity, the minimum transfer price is $14 + $8 lost contribution = $22. If it has spare capacity, the minimum is $14.

Key terms

• Residual income: Divisional profit less a charge for the capital employed.
• Goal congruence: The alignment of managers' actions with the goals of the whole organisation.
• Value for money: The combination of economy, efficiency and effectiveness.

Study tip: For transfer pricing, work out the minimum and maximum prices first. If the minimum is above the maximum, the transfer will not help the group.

Practice questions for section E

F. Employability and technology skills

Section F of the syllabus is about the skills needed to sit the exam on a computer. You need to be able to find and use the information given on screen, to work with spreadsheets and answer boxes for constructed responses, to move between windows and edit your answers, and to present data and information clearly. These skills are not learned from a textbook. ACCA says to practise with its CBE learning support content and the ACCA Practice Platform, so that you are confident with the question types before the live exam.

In the live exam you are given extra time to read the instructions, and a formulae sheet. Practise setting out calculations in the spreadsheet response area with clear workings, and writing short, structured answers for discursive requirements, with each point linked to the scenario.

Key terms

• Constructed response: A longer question for which you write your own answer, such as a calculation or a discussion.
• Formulae sheet: A sheet of formulae provided in the exam.

Study tip: Practise on ACCA's own practice platform. Setting out workings clearly earns marks even when the final figure is wrong.

Practice questions for section F