Part D Control and Performance Measurement of Responsibilty Centres
2. The concept of Value Chain
Porter grouped the various activities of an organisation into what he called the value chain; he divided the organizations activities into nine types, classified as either primary or secondary activities. These activities incur costs, but in combination with other activities provide customer satisfaction and therefore add value.
The main components are as follows:
Technology - R & D, product design and testing, process design and testing.
Inbound Logistics - Receiving, handling and storing inputs (warehousing, stock control, inbound transport).
Operations - Conversion of inputs (people, materials, machines etc) into the final product or service.
Marketing & Sales - Informing the customer (Marketing mix).
Outbound logistics - Delivery of the actual product or service (storage, outbound transport to customer).
Service - Customer service, repairs, installations, supply of parts/consumables.
175 | P a g e Value chain analysis is underpinned by the concept of quality which involves the following:
Commitment to developing processes that achieve high product quality and customer satisfaction
Commitment to continuous improvement
Involvement of the entire workforce
Quality assurance through statistical method a key component
The meaning of quality can be subjective but generally it can mean non-inferiority, superiority or usefulness of the product or service the customer is buying. A common interpretation of quality is "fitness for its use or purpose".
TQM is the process of embracing a quality conscious philosophy or culture, as well as adopting quality standards and procedures within an organisation, aiming towards perfection and continuous improvement.
Kaizen, the Japanese equivalent to TQM means continuous improvement by small incremental steps.
I hope you have found this report useful but should you require any further assistance or have any questions please do not hesitate to contact me.
Signed : Management Accountant.
B1 – 12 Inventory levels (CIMA P2 May 2008) Part (a)
Exam tip: The examiner is only after three cost changes being explained, however we have given you other cost changes that could be equally valid to discuss.
If Just-In-Time (JIT) were introduced the following cost changes would result:
Reduction in stock holding costs to nil as material is only used and bought if there is a demand being the philosophy of JIT.
Reduction in stock holding costs for finished goods and work in progress as all items will be sold to waiting customers.
Reduction in the number of suppliers used to ensure quality and consistency as material would go straight into production and there would be no time for quality control. This would increase the cost of materials however there would equally be a reduction to nil of internal quality control procedure costs.
176 | P a g e
Increase in price of raw materials from suppliers for regular small amounts ordered at short notice, but maybe reduced through the introduction of long-term exclusive contracts with suppliers.
Quality control costs will have to be put into place in the production process to eliminate scrap, re-works and defects which would delay despatch of goods to customers.
Staff training costs to ensure that they are able to use the new machinery efficiently and effectively and be able to maintain them.
Additional planning is required by management to ensure that there are no stock outs as JIT is based on the idea of holding zero stock, and therefore addition planning costs are needed.
Part (b)
Total quality management (TQM) is important to a company that operates a JIT production method because TQM means that the product is made to a very high standard reducing internal failure costs such as the inspection and scrap material and also reduction in external failure costs such as repairs and replacement.
JIT requires a TQM approach in order to operate holding zero stock levels and only producing if there is demand, being the philosophy of JIT. This would mean whatever is made must be to a high level of quality the first time and every time as there is no spare material to re-make a product that is defectively made. If defective products were made then production would have to stop while more material is sourced and the product re-made, this may cause a loss of sales and customer goodwill as we would not be able to deliver the product on time.
If the defective product were to be sold on to the customer this would cause the product to be sent back for repairs and customer confidence and goodwill being lost.
If TQM were adopted then it would encourage a quality conscious philosophy within staff culture, as well as adopting standards and procedures.
177 | P a g e B1 – 13 Workshop (CIMA P2 May 2008)
Part (a)
Y = aXb
Y = average time for that (X) number of units or the average cost per unit a = time for the first unit or the cost for the first unit
X = the number of units you want to calculate an average time or cost for b = the index of learning (log r/log 2)
a = 40 hours, b = log 0.8 / log 2 = -0.3219 To work out the time taken for the 8th batch:
Time for the first 8 batches 40 x (8 to the power of –0.3219) x 8 = 163.85 hours Time for the first 7 batches 40 x (7 to the power of –0.3219) x 7 = 149.67 hours Time for the 8th batch = 163.85 hours – 149.67 hours = 14.18 hours
Part (b)
The learning rate has reduced between months 2 and 4 from 75% to 90%. This maybe due to a number of reasons:
An increase in staff turnover and so new staff have to learn how to make these products efficiently and effectively and so require more time than the experienced staff who have left.
A gradual reduction in how much more that can be learned by the existing work force in the manufacturing of the product.
Inferior materials being introduced and so have led to more re-works and longer production times.
Production is no longer in its early stages and so great improvements have already been had.
Motivation and enthusiasm of the existing staff has fallen due to lack of incentives in perhaps skills or pay, and so therefore taking longer to produce the items.
178 | P a g e Part (c)
a = 45 hrs, y = 182.25 hrs / 8 batches = 22.78 hrs on average for 8 batches If we assume that “r” represents the learning rate, then:
Batches Average hours per unit
1 45
2 45 x r
4 45 x r x r
8 45 x r x r x r
Therefore for 8 batches:
45r³ = 22.78 r³ = 22.78 / 45 r³ = 0.506
r = (0.506) to the power of 1/3 r = 0.797
Therefore learning rate is 80%
B1 – 14 Out-turn performace report (CIMA P2 May 2010) Part (a) (i) (ii)
Flexed budget Actual Variance
Output (batches) 50 50
Direct labour hours 68.91 hours (W1) 93.65 hours 24.74 hours (A) Direct labour cost ($) $826.92 (W2) $1,146 $319.08 (A) Direct labour efficiency variance = 24.74 hrs x $12 per labour hr = $296.88 (A) Direct labour rate variance = $319.08 - $296.88 = $22.20 (A)
Workings
(W1) – Direct labour hours
The learning curve ceases once we reach 30 batches, meaning that labour will not get any faster in the production of any more units. Therefore we need to work out the total time for 30 batches and compare with the total time for 29 batches to obtain the time taken to make the 30th batch and use that as the time needed to make any further batches.
179 | P a g e Using the learning curve formula:
Y = aXb
Y = average time for that (X) number of units or the average cost per unit a = time for the first unit or the cost for the first unit
X = the number of units you want to calculate an average time or cost for b = the index of learning (log r/log 2)
a = 10 hours, b = -0.5146
Work out the average time for 30 batches:
Y = 10 x (30 to the power of –0.5146) = 1.737 hours Total time for 30 batches = 1.737 x 30 = 52.11 hours Work out the average time for 29 batches:
Y = 10 x (29 to the power of –0.5146) = 1.768 hours Total time for 29 batches = 1.768 x 29 = 51.27 hours
Time for the 30th batch = 52.11 hours – 51.27 hours = 0.84 hours
Total time for 50 batches = 52.11 hours + (20 batches x 0.84 hours) = 68.91 hours (W2) – Direct labour cost
68.91 labour hours x $12 per labour hour = $826.92 Part (b)
The original budget did not take into account the revised expectations of the learning curve for direct labour and therefore making comparisons is meaningless.
The original budget was not adjusted or flexed for the actual level of output to obtain a fair basis of what should be expected to be used in terms of resources and costs.
The revised out-turn performance report analyses the labour cost variance further into the efficiency variance and labour rate variance, thus allowing improved understanding of the real cause of the variance and then being able to assign responsibilities to the appropriate managers.
180 | P a g e B1 – 15 PQ (CIMA P2 May 2010)
(i) Selling price
PQ’s product being a consumer electronic product will have been a product that customers are willing to pay a premium for but this will not be sustainable as competitors will eventually enter the market. This will be seen during the growth stage as competition begins to enter the market, PQ will have to reduce its selling price; however PQ will still continue to increase contribution through economies of scale.
During the maturity and decline phase PQ will have to continue to reduce the selling price of their product in order to stay competitive, as closer more competitive substitutes will enter the market produced by other manufactures, these substitutes would have been created by manufactures purchasing PQ’s product and reverse engineering the product.
This approach will aim to sustain demand and contribution from PQ’s product as long the selling price is greater than the marginal cost of manufacturing the product. The cash flow will be used to develop other products in development.
In the decline phase PQ will further reduce the selling price of the product and it will eventually cease as there will be no extra benefit from this product as the product will have fallen out of favour with customers, and any of the product left will be sold at a vastly discounted selling price to clear it out of PQ’s inventory. The new more advanced replacement product will have been fully introduced.
(ii) Production costs
There will be a continued reduction in unit production costs of this product during its growth stage but unlikely to see any further reductions beyond this stage. This will be attributable to economies of scale being enjoyed by the company through mass production techniques, such as below:
Learning curve effects enjoyed by the workforce because the production is labour intensive, repetitive and most of the staff is retained over the long term.
Technical efficiencies learned by all departments in the manufacture of the product, especially the production department through improved understanding of how material and machines can be used more efficiently to maximise production.
Stock control systems will be more efficient if the company employs a JIT approach to stock management. This will reduce stock holding costs to nil and material is only used or bought if there is a demand.
Discounts will have been received as the company would buy more and more bigger batches of the raw material throughout the product’s life cycle.
181 | P a g e
Total quality management techniques will be used which means that the product will be made to a very high standard reducing internal failure costs such as the inspection and scrap material and also reduction in external failure costs such as repairs and replacement.
During the maturity phase there is unlikely to be any further significant cuts in unit variable costs, and in the decline phase the unit production cost will begin to increase.
This is expected as the demand for this product will be reduced significantly as it will have fallen out of favour with customers, and therefore less is being made and as a result fewer materials needed. The lower prices on raw materials cannot be enjoyed because of the reduced quantities bought by the company and hence the increase in unit production costs. In addition production costs will increase due to machine breakdowns and inefficiencies.
(iii) Selling and marketing costs
During the growth stage there will be much reduced expenditure on selling and marketing costs as there will be wide customer awareness of the product already and a minimal amount of expenditure will be required to reinforce the continued customer awareness of the product.
During the maturity stage such costs will be reduced further as the product is being more sold on reputation and word of mouth. Selling and marketing costs are not bringing any further benefit.
During the decline stage selling and marketing costs will cease as the product will fall out of favour with customers and will mainly become obsolete and production of which will also cease.
B1 – 16 Timber products (CIMA P2 May 2010) Part (a) (i) (ii)
The total production cost savings are $25,200 - $22,187.55 = $3,012.45.
182 | P a g e Workings
(W1) – Overtime costs
Month 3 = 220 std hours / 0.96 = 229.17 hours x $15 per hour = $3,437.55 Month 6 = 1,200 std hours / 0.96 = 1,250 hours s $15 per hour = $18,750 Part (b)
Only 2 factors are needed to be explained from the following:
1. There needs to be close relationships and contractual agreements with the suppliers which would need to be maintained throughout, since no inventory will be kept at XY for urgent requests such sales or defective items.
2. Smaller and more frequent deliveries will need to be planned and co-ordinated to coincide with production needs. The supplier may not have the logistics to support XY.
3. Higher quality machines will be needed with regular maintenance to avoid delays.
4. There will need to be involvement and training of staff to maintain flexibility of working hours and skills.
5. Staff need to take responsibility of their quality and so they need to be encouraged and motivated to do so.
B1 – 17 LMN (CIMA P2 May 2010) Part (a)
Performance within an organisation should be focused on assessing what can be controlled by divisions or individuals and omitting any items which are uncontrollable.
However this is clearly not the case here as there are issues the divisional directors are responsible for but are not within their control.
Three issues are as follows:
The investment decisions that divisional directors are responsible for maybe limited due to the $100,000 threshold. It is not clear as to the size of the divisions and therefore it cannot be ascertained with certainty if divisional directors can freely make meaningful independent decisions.
Head office costs are apportioned on an arbitrary basis with no consideration for the activities or costs expended in each of the decisions; furthermore the divisions do not have control over their own efficiency of resources that they use.
183 | P a g e
The transfer prices are enforced by head office and the divisional directors have no input into their calculations. It is not clear whether head office is imposing on divisions to transfer internally or whether they can decide themselves to purchase internally or externally. There is also no information on the extent of internal demand for goods and services.
Part (b)
Activity based costing (ABC) will look in more detail about what caused the head office costs to be incurred and will seek to work out many ‘cost drivers’ (activities). A cost driver is any factor that causes a change in the cost activity, so it is important to identify a causal relationship between the cost driver and the cost. So for example there maybe head office costs which do not relate to any activities of the divisions but are administrative expenses to support the organisation as a whole. These should be ignored as they cannot not be affected by decisions undertaken by the divisions. LMN must only look at costs which would occur due to the activities of the divisions, this may mean including other costs and removing others. This would then result in a fairer way to assess the divisions.
This would allow more efficient management of resources by understanding what drives costs incurred by divisions. There would be better costing information for planning and control for example and how different products, customers or distribution channels consume different resources. Furthermore, more realistic and competitive pricing to cover overheads and better profitability analysis because of improved accuracy over costs.
B1 – 18 Production manager (CIMA P2 Nov 2010) Part (a)
Flexed budget Actual output Revised flexed budget
Output 560 560 560
Direct labour hours 4,480 3,500 1,712 (W1)
Direct labour cost $67,200 $57,750 $25,680 Planning variance = flexed budget – revised flexed budget
Planning variance = $67,200 - $25,680 = $41,520 (F)
Labour efficiency variance = (actual hours – revised flexed hours) x std cost per hr Labour efficiency variance = (3,500 -1,712) x $15 = $26,820 (A)
Labour rate variance = actual hours at std rate – actual cost Labour rate variance = (3,500 x $15) - $57,750 = $5,250 (A)
184 | P a g e Workings
(W1) – Direct labour hours
Using the learning curve formula:
Y = aXb
Y = average time for that (X) number of units or the average cost per unit a = time for the first unit or the cost for the first unit
X = the number of units you want to calculate an average time or cost for b = the index of learning (log r/log 2)
a = 8 hours, b = -0.1520
Work out the average time for the first 560 units:
Y = 8 x (560 to the power of –0.5146) = 3.057 hours Total time for 560 units = 3.057 x 560 = 1,712 hours Part (b)
Target costing is a strategy which seeks to the selling price of a product at the market price which consumers are willing to pay, being the price that the product should be sold for in the market. Then deducting a desired level of benefit or profit for the organisation in order for the manufacture to be commercially viable, and then the product be manufactured within the value left over thereby becoming the budgeted costs or target costs.
Market price to achieve desired market share XX TARGET COST (balancing figure) (XX)
Desired profit XX
Learning curves is an important part of a target costing strategy as it will help in reducing costs within the business. It is only applicable to those businesses that have a labour intensive operation where savings can be made through experience and efficiencies. In a machine intensive operation these savings are limited as machines tend produce at the same rate. Businesses can achieve target costs once a certain level of activity has been achieved and so therefore for lessons can be learned and applied to standard costs once it is known the learning capacity of the labour force.
185 | P a g e B1 – 19 CAL (CIMA P2 Nov 2010)
Part (a)
Quality conformance costs are those costs which are spent to try to achieve a standard or target, such regulations or functional specifications of a product for a customer.
There are two main types of quality conformance costs:
Prevention costs – these are spent to try and ensure the product is made to detailed specifications and regulations. For example training staff, customer surveys, supplier reviews and investment in machines.
Appraisal costs – these are spent to understand how well a process has performed and corrective action is taken if needed subsequently. For example measuring equipment, inspections and tests, product quality audits.
Quality non-conformance costs are quality failure costs that are needed to correct products, as they did not meet expectations or target.
There are two main types of non-conformance costs:
Internal failure costs – these are quality failure costs before the products or services have been transferred to the customer. For example re-inspection of goods, losses or scrapping of materials and finished goods, additional administrative costs.
External failure costs - these are quality failure costs before the products or services have been transferred to the customer. External costs should be avoided as they expose poor manufacturing abilities to customers. Examples are administration of customer complaints, administration of customer services, product liability claims, repairs and replacements, lost goodwill and reputation.
It is clear from the scenario that CAL from a quality perspective provides middle range quality of solar panels, as they have competitors who sell at a cheaper price but offer an inferior range of solar panels and others who sell at a higher price but offer a high quality range of solar panels. CAL is losing out on an increase of 25% in its market share due to
It is clear from the scenario that CAL from a quality perspective provides middle range quality of solar panels, as they have competitors who sell at a cheaper price but offer an inferior range of solar panels and others who sell at a higher price but offer a high quality range of solar panels. CAL is losing out on an increase of 25% in its market share due to