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Performance Management | Page 2 of 107
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Special Offer
Place a http://accasupport.com link at any ONE of your
or
other account to get any TWO chapters above of your choice for free not
included in free version by emailing at kabuli_52@hotmail.com or
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Email should contain web page URL where you have placed a link and name
of any TWO chapters you want.
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Performance Management | Page 3 of 107
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KEY TERMS
A
Absorption Costing 40
Acid Test Ratio 129
Additive Model 114
B
Benchmarking 133
Blanket Rate or Single Factory Wide
Rate 41
C
Capacity Ratio 133
Cash Budgets 119
Clear 132
Coefficient of Correlation 114
Coefficient of Determination 114
Competitive Performance 133
Consumer Price Index (CPI) 114
Contribution 47
Controllability 132
Critical Success Factors (CSF) 132
Current Asset Ratio 129
Cyclical Variations 114
D
Departmental Overhead Absorption
Rate 42
Deseasonalisation 115
Determinants 132
Dimensions 132
I
Innovation 133
Interest Cover 129
Inventory Turnover 129
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Quality 132
Quick Ratio 129
M
Marginal Costing 47
Master Budgets 119
Material Cost Variance 121
Motivation 132
Multiplicative Model 115
O
Operating Profit Margin 128
Operational Gearing 129
Overhead Budget 119
Ownership 132
P
Payout Ratio 129
Pre-determined Overhead
Absorption Rate 40
Pre-Determined Overhead
Absorption Rate 40
Price Earnings (P/E) Ratio 129
Principle Budget Factor 119
Production Budget 119
Production Volume Ratio 133
S
Sales Budget 119
Seasonal Variations 114
Share Options 139
Standards 132
T
Trade Payable Turnover 129
Trade Receivable Turnover 129
Trend 114
V
Value for Money 133
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Variance 121
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Performance Management | Page 6 of 107
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AUTHORS PROFILE
Name: Murtaza Lanewala.
Career Status:
Freelance writer & tutor for
professional accountancy
qualifications. Professional bodies
include ACCA, CIMA and ICAEW.
Author & CEO of accasupport.com
E-mail:
kabuli_52@hotmail.com or
murtaza@accasupport.com
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Performance Management | Page 7 of 107
THIS MATERIAL IS NOT AVAILABLE OFFLINE IN ANY FORM & ONLINE EXCEPT ACCASUPPORT.COM
IMPORTANT!
1 Disclaimer
This material is sold only through accasupport.com website. However,
Clickbank.com is the credit card processing organization for collecting
payments for this material. This material is not available offline (shops,
schools etc.) in any form such as DVDs, CDs, Printed books etc. Materials
purchased from unauthorized source can be out of date and incomplete. In
addition, you will not be able to receive free updates given to the buyers of
original material.
Demo version of this material is available free of cost, please take care, not to
pay for demo version of this e-book to unauthorized sellers.
Readers of this material will be solely responsible for the consequences of any
decisions made in real life. Author & accasupport.com are not responsible to
the readers of this material under any circumstances.
Recommendations made of any kind are intelligent guesses to the best of
authors knowledge.
Names of individuals, organizations, countries, religions etc are used for
educational purpose only. It is not intended to abuse, discriminate and heart
anyone's feelings and dignity.
2 Copyright Notice
This material is subject to copyright protection law. Infringement of copyright
law results in criminal liability (fine or imprisonment or both).
Copyright infringement is effectively theft of intellectual property; therefore, it
is unethical from social viewpoint and sinful act from religious viewpoint as
well.
Copyright 2012 Murtaza Lanewala. All rights reserved.
2.1 Do
You can make a backup copy of this material.
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Performance Management | Page 8 of 107
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You can use parts of this material provided you quote the appropriate
reference to the author and material.
2.2 Do Not
You cannot publicly share this material in the form of hard copy or soft copy
(physically and over the internet) for cash or for free.
You cannot transform this material into other means of communication such
as photocopy, video, audio etc. Unless needed for accessibility purpose or
personal use.
You cannot change the file format of this material or make it editable.
You cannot resell this material unless you are selling the original copy
purchased.
You cannot use any part of this material in or with contents associated with
violence, politics, religious and pornographic contents in any way.
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Performance Management | Page 9 of 107
Chapter 1: ACTIVITY BASED COSTING
Chapter 1:
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Performance Management | Page 10 of 107
Chapter 1: ACTIVITY BASED COSTING
1 Absorption Costing
Absorption costing is the traditional technique for recovering (absorbing)
overheads (indirect costs) via including it in products cost on some fair basis.
It is due to overhead costs, which form, significant part of the product cost
cannot be identified directly and allocated, like direct material & direct Labour.
Need for absorbing overhead arises when organization manufactures more
than one type of product. Each product may consume different amount
resources and therefore consumes different amount of overhead cost.
In service industries, absorption costing is used to absorb overheads cost
incurred into services provided.
In retail organizations, there are no or little overheads, such as packaging and
labelling. These overhead costs are unlikely to be significant and therefore,
cost incurred in absorbing overhead cost into products may not exceed
revenue. Therefore, overheads are treated as period cost rather than included
into product cost.
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Performance Management | Page 11 of 107
Chapter 1: ACTIVITY BASED COSTING
A laundry shop, where cloths are washed and dried using washing machines.
An organization selling handmade biscuits, in which every work from making
dough to rolling and cooking are all Labour intensive operations.
2.1.1 Calculating Blanket Rate
Formula:
Illustration:
Organization has following detail for overhead cost in the upcoming period.
Expenses
$
Factory rent
50,000
Power cost
15,000
Machine & tools depreciation
10,000
Machine maintenance cost
6,000
Cleaning & hygiene
4,000
Subsidized canteen
5,000
Total allocated overheads
328,000
Total reapportioned overheads 418,000
Machine hours
Labour hours
Total
18,200
20,000
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Performance Management | Page 12 of 107
Chapter 1: ACTIVITY BASED COSTING
Illustration:
Organization has following detail for overhead cost in the upcoming period.
Expenses
Factory rent
Power cost
Machine & tools depreciation
Machine maintenance cost
Cleaning & hygiene
Subsidized canteen
$
50,000
15,000
10,000
6,000
4,000
5,000
30
8,000
30
5,000
5
1000
5
1000
100
20,000
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Performance Management | Page 13 of 107
Chapter 1: ACTIVITY BASED COSTING
Solution:
Factory rent
Power cost
Machine & tool
depreciation
Machine maintenance
cost
Cleaning and hygiene
Subsidized canteen
Total overhead costs
Cleaning cost
Canteen cost
Cleaning cost
Canteen cost
Total allocated
overheads
2,637
1,319
1,055
659
0
0
25,970
2,449
28,419
3,941
32,360
210
32,570
8.2
32,578.2
0
0
22,454
2,449
24,903
3,941
28,844
210
29,054
8.2
29,062.2
0
0
21,750
2,449
24,199
3,941
28,140
210
28,350
8.2
28,358.2
4,000
0
7,652
(7,652)
0
657
657
(657)
0
1.37
1.37
106,000
138,578.2
108,000
137,062.2
114,000
142,358.2
1.37
Total
$
50,000
15,000
10,000
330
6,000
5,000
12,175
306
12,481
(12,481)
0
26
26
(26)
0
4,000
5,000
90,000
0
90,000
0
90,000
0
90,000
0
90,000
328,000
418,000
Explanation
To determine cutting department overheads based on machine hours as
cutting department seems to be machine intensive.
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Performance Management | Page 14 of 107
Chapter 1: ACTIVITY BASED COSTING
Explanation
To determine assembling department overheads based on Labour hours as
assembling department seems to be Labour intensive.
Explanation
To determine finishing department overheads based on Labour hours as
finishing department seems to be Labour intensive.
2.3 Selection of Basis for Overhead Absorption Rates
The following bases for absorption of overheads are usually used but other
methods are also possible. Organization may choose any other method as it
consider appropriate. These are:
No of units produced.
No of labour hours.
No of machine hours.
Total direct material cost.
Total direct Labour cost.
Prime cost (Direct material + Direct Labour + Direct expenses). It is the sum
of all direct costs.
Conversion cost (Direct Labour + Factory Overheads). It is the cost of
converting material into finished goods.
Details
$
X
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Performance Management | Page 15 of 107
Chapter 1: ACTIVITY BASED COSTING
Costs
Details
Direct Labour
Direct expense
Prime cost
Production overheads (Based on absorption rate)
Product cost
Admin overheads
(Period cost)
Selling & distribution (Period cost)
$
X
X
X
X
X
X
X
X
X
Full cost
Illustration:
An organization has following data for calculating product cost in upcoming
period.
Direct Material
$300,000
Direct Labour
$250,000
Direct Expenses
$100,000
Workings
(Budgeted)
$
Workings
300,000 ($300,000/10,000)
250,000 ($250,000/10,000)
100,000 ($100,000/10,000)
650,000
($22.967 x
418,000
18,200hrs/10,000units)
$/unit
30
25
10
65
41.80
1,068,000 ($1,068,000/10,000)
106.8
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Performance Management | Page 16 of 107
Chapter 1: ACTIVITY BASED COSTING
Workings
Product cost
Admin overheads
Selling &
distribution
Full cost
$
1,068,000
(Period cost)
50,000
($5 x 10,000)
50,000
1,168,000
Workings
300hrs x $15/hr
300hrs x $10/hr (W1)
11,000 x 150%
GC
3,500
4,500
3,000
11,000
16,500
Workings
500hrs x $15/hr
500hrs x $10/hr (W1)
20,500 x 150%
EX
8,000
7,500
5,000
20,500
30,750
Workings:
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Performance Management | Page 17 of 107
Chapter 1: ACTIVITY BASED COSTING
4 Marginal Costing
Marginal costing is the technique used to determine product cost and used for
other short-term decision-making purpose.
Examples:
Whether to manufacture in-house or buy from external supplier.
How much of each product should be manufactured.
Whether to accept or reject offer made by customer or supplier.
Whether to continue or discontinue an operation.
Marginal costing only considers variable costs as relevant for decision-making.
It considers all fixed costs as irrelevant and so it is not taken into account for
short-term decision-making.
Marginal costing recognizes fixed costs as irrelevant because in short-term,
fixed cost remains constant (unchanged) with change in activity level.
Marginal costing not only considers production costs (Material, Labour and
Overheads) as variable; it also considers non-production variable costs (Selling
& distribution, administration and finance overheads) as relevant for product
costing. Marginal costing leads to all variable costs being considered in
decision-making process.
5 Contribution
Contribution is figure obtained after deducting all variable costs from sales.
Marginal costing considers only contribution as relevant for decision-making
rather than profit.
5.1 Calculating Contribution & Profit in Marginal Costing
Formula:
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Performance Management | Page 18 of 107
Chapter 1: ACTIVITY BASED COSTING
$
Sales revenue
Variable costs (Product Cost)
Direct material
Direct Labour
Variable production overheads
Variable selling & distribution overheads
Variable administration overheads
Total variable cost
Contribution
Fixed costs (Period Cost)
Fixed production overheads
Fixed selling & distribution overheads
Fixed administration overheads
Total fixed cost
Net Profit
$
X
(X)
(X)
(X)
(X)
(X)
(X)
X
(X)
(X)
(X)
(X)
X
Illustration:
An organization has sales revenue of $1,000,000 and following costs:
Direct materials
Direct Labours
Variable production overheads (indirect material + indirect Labour)
Fixed production overheads
Selling & distribution overheads (60% fixed cost)
Administration overheads (80% fixed cost)
Finance overheads (100% fixed cost)
$(000)
100
150
100
150
150
120
50
Required:
Calculate contribution and profit. Comment on the results.
Solution:
$(000)
Sales revenue
Variable costs (Product Cost)
Direct materials
Direct Labours
Variable production overheads
Selling & distribution overheads ($150 x 40%)
Administration overheads ($120 x 20%)
Total variable costs
Contribution
Fixed costs (Period Cost)
Fixed production overheads
$(000)
1,000
100
150
100
60
24
434
566
150
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Performance Management | Page 19 of 107
Chapter 1: ACTIVITY BASED COSTING
$(000)
90
96
$(000)
336
230
Profit
Profit is relevant in the long-term.
Profit is subjective indicator of
organizational performance, as it
requires absorption of fixed costs on
some fair basis.
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Performance Management | Page 20 of 107
Chapter 1: ACTIVITY BASED COSTING
Contribution
Contribution is more useful for
management accounting purpose.
Management accountants have to
assist managers in their day-to-day
decision-making.
Contribution is only useful for shortterm planning and control as it
ignores fixed costs.
Profit
Profit is more useful for financial
accounting purpose so that
management can be held accountable
for total cost (variable + fixed) incurred.
Profit is useful for long-term planning
and control as it takes account of
variable as well as fixed costs. In longterm, all fixed costs are considered as
variable.
Profit reflects both cash & non-cash
income/expenditures such as interest
receivable, depreciation respectively.
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Performance Management | Page 21 of 107
Chapter 1: ACTIVITY BASED COSTING
6.2.3 Step3
Determine ABC absorption rate by dividing cost pool with total number of
activity performed by respective cost driver.
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Performance Management | Page 22 of 107
Chapter 1: ACTIVITY BASED COSTING
Formula:
Example:
Long distance delivery cost with number of long distance deliveries.
6.2.4 Step4
Absorb (allocate) overhead cost using ABC absorption rate to products.
Multiply the ABC absorption rate with total number of activity consumed by
each product.
Formula:
Example:
Product A has consumed 400 long distance deliveries and 1,000 short distance
deliveries.
Product B has consumed 500 long distance deliveries and 400 short distance
deliveries.
6.2.5 Step5
Total all the allocated overhead costs for each product and also add direct
material and direct labour cost to determine full cost of product.
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Performance Management | Page 23 of 107
Chapter 1: ACTIVITY BASED COSTING
To determine unit cost of a product by dividing full product cost with total
activity level of a product.
Activity level can be either production volume or sales volume. Production
volume should be used when costing for product or production related
activities. Sales volume should be used when costing for sales related activity
such as customer order deliveries.
To determine selling price add mark-up percentage. Mark-up percentage will
be given in the question.
Example:
Organization wishes to earn 20% profit margin on a product.
If you are given profit margin, then covert margin into mark-up, using following
formula:
Formula:
Activity driver
Site visits
Planning documents
Labour hours
Total number
of activities per year
500
250
40,000
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Performance Management | Page 24 of 107
Chapter 1: ACTIVITY BASED COSTING
Annual overheads
Overhead category
$
Total
400,000
Activity driver
Total number
of activities per year
A typical GC costs $3,500 in materials and takes 300 labour hours to complete.
A GC requires only one site visit by a supervisor and needs only one planning
document to be raised. The typical DC costs $8,000 in materials and takes 500
hours to complete. An EX requires six site visits and five planning documents.
In all cases, labour is paid $15 per hour.
Required:
Calculate the cost and the quoted price of a GC and of an EX using ABC to
absorb the overheads.
Solution:
Quoted Price Using ABC
Workings
Materials
Labour
(300 x $15/hr)
(500 x $15/hr)
Overheads (step3)
Supervisor
Planners
Property
Full Cost
Mark up 50% on cost
Quoted Price
GC $
3,500
4,500
EX $
8,000
7,500
180
280
1,800
10,260
5,130
15,390
1,080
1,400
3,000
20,980
10,490
31,470
Workings:
Step1 (optional)
Cost Pool
Cost Driver
Supervisors
Site visits
Planners
Property
related
Planning
documents
Labour hours
Reason
Monitoring sites incurred supervisors
cost
Planning documents incurred planners
cost
Labours are used to complete property
contracts.
Step2
In this question, there is one cost driver for each cost pool, so there no need
for cost pool apportionment.
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Performance Management | Page 25 of 107
Chapter 1: ACTIVITY BASED COSTING
Step3
Cost pool
Annual overheads in $ Total number of activities ABC absorption rate
Supervisors
90,000
500
180
Planners
70,000
250
280
Property related 240,000
40,000
6
Step4
Cost Pool
Activities consumed
Supervisors
1:6
Planners
1:5
Property related
6:6
GC
(1 x 180)180
280
1,800
EX
(6 x 180)1,080
1,400
3,000
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Performance Management | Page 26 of 107
Chapter 1: ACTIVITY BASED COSTING
Some products may require more setups because of production in smaller and
more frequent batches. These may be slow moving products or products of
perishable nature, which will become obsolete if stored for longer time.
Conversely, some products may require fewer setups because of production in
larger batches. These may be fast moving products or products having
unpredictable demand, which needs to be stored to meet unexpected demand.
Activity based costing differentiates cost drivers between activity based cost
drivers and volume based cost drivers.
Activity based cost drivers change with changes in number of activities (setup,
invoicing, deliveries etc).
Volume based cost drivers change with changes in volume (labour or machine
hours, units etc). Some overhead costs are still change with volume such as
machine depreciation.
Activity based costing takes account of the fact that it is number of activities
which incurs majority of the costs rather volume (labour or machine hours) of
the product.
In todays manufacturing environment, responsiveness to customer is
considered as the key to success. It gives rise to number of supporting activities
and related costs. It makes activity-based cost drivers significant part of
overheads cost rather than volume based cost drivers.
Activity based costing closely allocates each type of overhead cost to
respective activities which incur cost rather than allocating all types of
overhead costs on single factory wide or departmental overhead rate (labour
or machine hours). Therefore, ABC costing makes use of greater number of
overhead absorption rates rather than two or three overhead absorption rates
used in absorption costing.
Activity based costing gives fairer reflection of actual overheads incurred by
each product.
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Performance Management | Page 27 of 107
Chapter 1: ACTIVITY BASED COSTING
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Performance Management | Page 28 of 107
Chapter 1: ACTIVITY BASED COSTING
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Performance Management | Page 29 of 107
Chapter 1: ACTIVITY BASED COSTING
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Performance Management | Page 30 of 107
Chapter 1: ACTIVITY BASED COSTING
Absorption Costing
Absorption costing
conventionally absorbs
only production
overheads in product
cost.
ABC gives more realistic Absorption costing
and detailed information makes use of subjective
for product costing and
basis for allocation,
long-term decisionapportionment and
making purpose such as absorption of overheads
product pricing.
Example:
Floor area for rent
As it considers all the
costs as variable in long- apportionment and
machine or labour hours
term. ABC focuses on
for absorption.
activities and includes
most of the
Therefore, it is of little
organizational cost in
use in decision-making,
product cost.
and product costing
based on absorption
However, there is still
costing can be
subjective grouping of
costs into cost pools and misleading.
identification of cost
drivers.
ABC can be used for
Absorption costing can
financial reporting
be used for financial
purpose
reporting purpose.
Marginal Costing
Marginal costing does
not include fixed costs,
even fixed production
overheads in product
cost.
Marginal costing is
suitable for short-term
decision-making.
Example:
Decisions for accepting
or rejecting customer
order.
As it only considers
variable costs and
ignores fixed costs. It
does not ensure full
recovery of fixed cost in
long-term.
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Performance Management | Page 31 of 107
Chapter 1: ACTIVITY BASED COSTING
ABC
ABC allocates cost
according to the activity
and volume consumed
by each product.
As it recognizes the
difference between cost
increasing with volume
(volume based cost
drivers) and cost
increasing with activities
(activity based cost
drivers)
Absorption Costing
Absorption costing
allocates more overhead
costs to high volume
products and low activity
products.
Marginal Costing
Conversely, it allocates
less overhead costs to
low volume high activity
products.
It leads to dysfunctional
(misleading) decisionmaking.
1
20
750
Product C
1
1
12
1,250
Product P
1
3
25
7,000
Direct labour costs $6 per hour and production overheads are absorbed on a
machine hour basis. The overhead absorption rate for the period is $28 per
machine hour.
Total production overheads are $654,500 and further show that the total
production overheads can be divided as follows.
%
Costs relating to setups
35
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Performance Management | Page 32 of 107
Chapter 1: ACTIVITY BASED COSTING
%
Costs relating to machinery
Cost relating to materials handling
Costs relating to inspection
Total production overhead
20
15
30
100
The following total activity volumes are associated with each product line for
the period as a whole.
Number of Number of movements
Product D
Product C
Product P
set ups
75
115
480
670
of materials
12
21
87
120
Number of
inspections
150
180
670
1,000
Required:
a) Calculate the cost per unit for each product using traditional methods,
absorbing overheads based on machine hours.
b) Calculate the cost per unit for each product using ABC principles (work to
two decimal places).
c) Explain why cost per unit calculated under ABC are often very different to
costs per unit calculated under more traditional methods. Use the information
for triple limited to illustrate.
d) Discuss the implications of a switch to ABC on pricing and profitability.
Solution
(a)
Material
Labour
Production overhead
Cost per unit
Diva
Classic
Poser
20
($6 x hr) 3
($28 x 1.5hrs) 42
65
12
($6 x 1.5hrs) 9
($28 x 1hr) 28
49
25
($6 x 1hr) 6
($28 x 3) 84
115
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Performance Management | Page 33 of 107
Chapter 1: ACTIVITY BASED COSTING
Marking Scheme
For each product 1 mark
Total
3 marks
(b)
Let use step-by-step procedure to solve this question (this representation is for
tutorial purpose and lengthier than you would be expected to fulfil
requirement. Past paper is more useful for planning your representation for
exam purpose).
Cost Per Unit
Workings
Material
Labour
Overhead
($77,213/750)
Diva ($)
20
3
94.95
($98,843/1,250)
Classic ($)
12
9
79.07
($484,444/7,000)
Cost per unit
Poser ($)
25
6
117.95
100.07
69.21
100.21
Workings:
Examiners Note:
Each step required has been given its own sub-heading to make the procedure
clear. The basic principle is to find an overhead cost per unit of activity for each
element of overhead cost. In some cases, it might be possible to find an
overhead cost per unit directly; here it is probably easier to split overhead
between each product type first and then find a cost per unit as shown.
(Optional)
Cost Pool
Set up cost
Cost driver
Number of setups
Machining cost
Machine hours
Material movement
Reasons
Set up cost arises each
time new batch of
production in launched.
It rises due to
depreciation and
maintenance of machine.
It arises each time
material is moved
around the factory.
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Performance Management | Page 34 of 107
Chapter 1: ACTIVITY BASED COSTING
Cost Pool
Inspection cost
Cost driver
Number of inspections
Reasons
Inspection cost arises
each time inspection is
made.
Machine hour/unit
1
3
Apportioned
cost ($)
35 229,075
20 130,900
15 98,175
30 196,350
Cost Driver
Number of set ups
Machine hours
Material
movements
Number of
inspections
Activity level
670
23,375
120
1,000
196.35
100 654,500
Cost per
driver ($)
341.90
5.60
818.13
196.35
Respective activities
75 : 115 : 408
1,125 :1,250 :21,000
12 :21 : 87
150 : 180 : 670
Marking Scheme
Total machine hours
Cost per driver calculation
Overheads split by product table
Cost per unit calculation
Total
Diva
($)
25,643
6,300
9,817
29,453
77,213
Classic
($)
39,319
7,000
17,181
35,343
98,843
Poser
($)
164,113
117,600
71,177
131,554
484,444
Total ($)
229,075
130,900
98,175
196,350
654,500
2 marks
3 marks
4 marks
3 marks
12 marks
Exam Support
Use tabular approach to save time and enhance representation and
understanding.
(C)
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Performance Management | Page 35 of 107
Chapter 1: ACTIVITY BASED COSTING
Volume in units
Absorption costing
Activity based costing
Diva
(1,125 Mac hrs) 750
$42
$95
Classic
(1,250 Mac hrs) 1,250
$28
$79
Poser
(21,000 Mac hrs) 7,000
$84
$69
Diva
(1,125 mac hrs) 750
$42
$95
Classic
(1,250 mac hrs)1,250
$28
$79
Poser
(21,000 mac hrs) 7,000
$84
$69
Exam Support
Do not reproduce same comments repeatedly in exams. Doing so will not earn
you marks instead it will consume time.
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Performance Management | Page 36 of 107
Chapter 1: ACTIVITY BASED COSTING
If triple ltd is using full cost plus pricing without considering market conditions,
then it would be selling its lower cost products Diva and Classic at lower selling
price and higher cost products at higher selling price.
On the basis absorption costing, product Diva and Classic would be sold at
lower price and poser at higher prices. It might lead to losses on lower cost
products (Diva and Classic) seems to be profitable to triple ltd and higher cost
product might be discontinued as it seems uneconomical to customers in
comparison with its Quality due to lower activity consumption such as number
of inspections.
Therefore, absorption costing would encourage managers to produce more
and more units of lower cost products and reducing or eliminating the
production of higher cost products. It results in dysfunctional (misleading)
decision-making.
Under ABC manager will have true information related to cost of each product,
so competitive selling price can be charged to customers to competitive
advantage in the market.
In price sensitive market, product Poser should be given first priority and
product Diva should be given least priority. This will increase overall
profitability of triple ltd.
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Performance Management | Page 37 of 107
Chapter 2: LIFE CYCLE COSTING
Chapter 2:
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Performance Management | Page 38 of 107
Chapter 2: LIFE CYCLE COSTING
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Performance Management | Page 39 of 107
Chapter 2: LIFE CYCLE COSTING
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Performance Management | Page 40 of 107
Chapter 2: LIFE CYCLE COSTING
Labour efficiency is increased to its full potential. Labours are making more
products per hour resulting in reduced labour cost.
Overhead cost low due to economies of scales.
Products are of high quality and reduce warranty claim cost.
Minimal training and supervision cost than above stages.
Revenues are at peak and product is generating high cash flow balance
ever.
Competitor try to penetrate (enter) the market reducing their selling price.
This puts increased demand for product quality to maintain selling price.
2.5 Decline
Customers are getting bored of the product and looking for other products
offered by competitor or newer version of existing product.
Marketing expenditure can generate some interest in product particularly in
lower income group.
Product cost begin to rise because of
Production volume is reduced due to reduction in demand, resulting in loss
of economies of scale.
Changes in product design can increase the life of products perhaps at some
costs. Cost should only be incurred if expected benefits are greater than
cost.
Product can still be profitable (cash generating) because of competitors
leaving the market. As a result price pressures are decreased and
organization can enjoy monopoly position in the market.
Competitor may leave because find the market unattractive and want to
pursue other interests.
Finally, at the end of life cycle product is discontinued.
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Performance Management | Page 41 of 107
Chapter 2: LIFE CYCLE COSTING
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Performance Management | Page 42 of 107
Chapter 3: TARGET COSTING
Chapter 3:
TARGET COSTING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
What Is Target Costing?
2
Steps Involved In Target Costing
3
Calculating Target Cost/Unit & Cost Gap
4
Strategies to Reduce Cost
5
Benefits of Target Costing
6
Target Costing In Service Industries
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Performance Management | Page 43 of 107
Chapter 3: TARGET COSTING
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Performance Management | Page 44 of 107
Chapter 3: TARGET COSTING
These steps will be continuously repeated until the end of product life cycle.
Diagram:
Estimated cost
Target
cost
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Performance Management | Page 45 of 107
Chapter 3: TARGET COSTING
Component 1 (Circuit board) these are bought in and cost $410 each. They
are bought in batches of 4,000 and additional delivery costs are $2,400 per
batch.
Component 2 (Wiring) in an ideal situation 25 cm of wiring is needed for
each completed radio. However, there is some waste involved in the process
as wire is occasionally cut to the wrong length or is damaged in the assembly
process. Edward Co estimates that 2% of the purchased wire is lost in the
assembly process. Wire costs $050 per metre to buy.
Other material - other materials cost $8 10 per radio.
Assembly labour these skilled people are difficult to recruit and retain.
Edward Co has more staff of this type than needed but is prepared to carry this
extra cost in return for the security it gives the business. It takes 30 minutes to
assemble a radio and the assembly workers are paid $1260 per hour. It is
estimated that 10% of hours paid to the assembly workers is for idle time.
Production Overheads recent historic cost analysis has revealed the following
production overhead data:
Total production Total assembly
overhead
labour hours
$
Month 1 620,000
19,000
Month 2 700,000
23,000
Fixed production overheads are absorbed on an assembly hour basis based on
normal annual activity levels. In a typical year 240,000 assembly hours will be
worked by Edward Co.
Required:
Calculate the expected cost per unit for the radio and identify any cost gap that
might exist.
Solution:
Component 1
Workings
4.10+($2,400/4,000)
$/unit
Explanation
470 Material cost + delivery
cost
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Performance Management | Page 46 of 107
Chapter 3: TARGET COSTING
Component 2
Other material
Labour cost
Variable
production
overhead (W1)
Fixed production
overhead (W1)
Estimated or
budgeted cost
Expected or
desired cost
Cost gap
Workings
25/100 x 100/98 x
$0.5
30/60 x 100/90 x
$12.60
30/60 x $20
30/60 x $12
$44 x(100-20)%
$/unit
Explanation
0128 Centimetre to metre x
gross up for wastages x
material cost
8.10
7
0.5 hours x gross up for idle
time x labour rate
10
Variable overhead incurred
during labour making
products.
6
Fixed overhead absorbed
on the basis of labour
hours
35928 Based on management
accounting information
35.20 Market selling price less
desired profit margin.
0.728 Cost reduction required.
Workings
High low method to variable and fixed components of overhead cost.
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Performance Management | Page 47 of 107
Chapter 3: TARGET COSTING
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Performance Management | Page 48 of 107
Chapter 3: TARGET COSTING
Even if the comparable services can be found it is still difficult to apply its price
to the services of the organization.
It is due to the characteristics of services (intangible, perishable,
heterogeneous, simultaneous and no transfer of ownership).
There can be more than one organization charging different prices for their
same or similar services. Then it becomes a subjective (biased) matter of
judgement.
In service industries person incurring the cost is not the person responsible for
costs. It adds difficulty in managing costs.
Example:
In hospital, costs are incurred because of decision taken by doctors and the
responsibility to manage costs relies on administration staff.
Also in service industries cost managers has no control over process of
providing the service. It is because of services are of technical in nature and
cost manager may not have such technical skills.
Example:
If you are assumed as cost controller then may not control the way mechanic
repairs your car.
Each time service is provided, it results in different cost and quality.
Example:
Hairdresser takes different amount of time each time you visit saloon.
Sometimes haircutting may not result as you wished.
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Performance Management | Page 49 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
Chapter 4:
THROUGHPUT ACCOUNTING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
What Is Throughput Accounting
2
Principle Resource Factor
3
Calculating Throughput Accounting Ratio (TPAR)
4
Calculating Optimal Product or Process Mix
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Performance Management | Page 50 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
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Performance Management | Page 51 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
This formula is applied for each process or resource over number of products
given in question.
Process or resource giving lowest number of units for products in total is the
principal resource factor.
Illustration:
The factory has 50 production lines each of which contain the three processes:
Raw material for the sheet metal is first pressed then stretched and finally
rolled. The processing capacity varies for each process and the factory manager
has provided the following data:
Processing time per metre in hours
Product A
Product B
Product C
Pressing
0.50
0.50
0.40
Stretching
0.25
0.40
0.25
Rolling
0.40
0.25
0.25
The factory operates for 18 hours each day for five days per week. It is closed
for only two weeks of the year for holidays when maintenance is carried out.
On average one hour of labour is needed for each of the 225,000 hours of
factory time. Labour is paid $10 per hour.
Required:
Identify the bottleneck process and briefly explain why this process is
described as a bottleneck.
Solution:
Products
Total
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Performance Management | Page 52 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
Pressing process has the ability to make lowest number of units is the
bottleneck process. Hence, it is limiting the capacity of Yam co to make more
than 1,462,500 units during factory hours.
Workings
Budgeted factory hours given is 225,000 hrs. It can also be calculated as
follows
Pressing Process
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Performance Management | Page 53 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
Where
Factory hours are the number of hours for which factory gate remains open
Example:
5 workers work 5,000 hours per year during the same timings. Factory hours
will be 5,000 hrs because it does not matter how many hours are paid per year,
what matter is how long factory remained open per year.
This formula compares throughput on principal resource with conversion cost
incurred for whole factory during factory hours.
If TPAR is greater than 1, it means product is generating more cash
(throughput) than cash spent on running the factory.
If TPAR is lesser than 1, it means product is losing cash in each hour product is
made in the factory. It is due to cash generated from product is less than cash
spent on running the factory.
That product should be discontinued unless needed for other strategic
purpose.
Illustration:
Thin Co is a private hospital offering three types of surgical procedures known
as A, B and C. Each of them uses a pre-operative injection given by a nurse
before the surgery. Thin Co currently rent an operating theatre from a
neighbouring government hospital. Thin Co does have an operating theatre on
its premises, but it has never been put into use since it would cost $750,000 to
equip. The Managing Director of Thin Co is keen to maximise profits and has
heard of something called throughput accounting, which may help him to do
this. The following information is available:
All patients go through a five step process, irrespective of which procedure
they are having:
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Performance Management | Page 54 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
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Performance Management | Page 55 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
Procedure A
Procedure B
Procedure C
Hours
Hours
Hours
per procedure per procedure per procedure
Advisor
0.24
0.24
0.24
Nurse
0.27
0.28
0.30
Anaesthetist
0.25
0.28
0.33
Surgeon
0.75
1
1.25
Recovery specialist
0.60
0.70
0.74
Part hours are shown as decimals e.g. 024 hours = 144 minutes (024 x 60).
Surgeons hours have been correctly identified as the bottleneck resource.
Required:
a) Calculate the throughput accounting ratio for procedure C.
Note: It is recommended that you work in hours as provided in the table rather
than minutes.
b) The return per factory hour for products A and B has been calculated
and is $2,61253 and $2,65440 respectively. The throughput accounting
ratio for A and B has also been calculated and is 896 and
911respectively.
Calculate the optimum product mix and the maximum profit per annum.
Solution to Requirement (a)
$/unit
4,250
1,000
45
560
1,050.60
3,19940
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Performance Management | Page 56 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
B
911
1
C
878
3
Hours taken
800
450
630
1,880
Total
throughput
2,123,520
1,175,6385
1,612,4976
4,911,6561
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Performance Management | Page 57 of 107
Chapter 4: THROUGHTPUT ACCOUNTING
What product should be made first to make sure it gets sufficient resources to
meet the demand with respect to it.
How much of each product should be made taking account of any principle
factor associate with product (government restriction to make above certain
level) or production process (availability of resources such as labour hours and
machinery condition).
Illustration:
The return per factory hour for products A and B has been calculated and is
$2,61253 and $2,65440 respectively. The throughput accounting ratio for A
and B has also been calculated and is 896 and 911respectively.
Required:
Calculate the optimum product mix and the maximum profit per annum.
Solution to Requirement (b)
A
TPAR
896
RANK
2
B
911
1
C
878
3
Total throughput
2,123,520
1,175,6385
1,612,4976
4,911,6561
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Performance Management | Page 58 of 107
Chapter 5: ENVIRONMENTAL ACCOUNTING
Chapter 5:
ENVIRONMENTAL ACCOUNTING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Environmental Management Accounting
2
Benefits of Environmental Management Accounting
3
Methods of Environmental Accounting
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Performance Management | Page 59 of 107
Chapter 5: ENVIRONMENTAL ACCOUNTING
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Performance Management | Page 60 of 107
Chapter 6: RELEVANT COSTING
Chapter 6:
RELEVANT COSTING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Relevant Cost Vs Irrelevant Cost
2
Materials
3
Labour
4
Overheads
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Performance Management | Page 61 of 107
Chapter 6: RELEVANT COSTING
2 Materials
2.1 Spare Materials
2.2 Material in Use
3 Labour
3.1 Spare Labour
3.2 Labour in Use
4 Overheads
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Performance Management | Page 62 of 107
Chapter 6: RELEVANT COSTING
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Performance Management | Page 63 of 107
Chapter 6: RELEVANT COSTING
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Performance Management | Page 64 of 107
Chapter 7: SHORT TERM DECISION-MAKING
Chapter 7:
SHORT-TERM DECISION-MAKING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Outsourcing Benefits & Limitations
2
Incremental Costs & Revenues
3
Make or Buy Decision
4
Continue or Discontinue Decision
5
Further Processing Decisions
6
Non-Financial Factors Involved In Further Processing Decision
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Performance Management | Page 65 of 107
Chapter 7: SHORT TERM DECISION-MAKING
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Performance Management | Page 66 of 107
Chapter 7: SHORT TERM DECISION-MAKING
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Performance Management | Page 67 of 107
Chapter 8: COST VOLUME PROFIT ANALYSIS
Chapter 8:
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Performance Management | Page 68 of 107
Chapter 8: COST VOLUME PROFIT ANALYSIS
2 Basic Terms
2.1 Breakeven Point (BEP)
2.2 Margin of Safety (MOS)
2.3 Calculating Breakeven Point
2.4 Calculating Margin of Safety
2.5 Calculating Target Profit or Revenue
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Performance Management | Page 69 of 107
Chapter 9: PRICING DECISIONS
Chapter 9:
PRICING DECISIONS
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Pricing Strategies
2
Calculating Prices for Different Pricing Strategies
3
Price Demand Relationship
4
Price Elasticity of Demand
5
Calculating Price Elasticity of Demand
6
Determining Optimal Selling Price, Sales Volume & Profit
7
Non-Financial Aspects of Pricing Decision
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Performance Management | Page 70 of 107
Chapter 10: LINEAR PROGRAMING
1 Pricing Strategies
1.1 Price Penetration
1.2
Discounted-Pricing
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Performance Management | Page 71 of 107
Chapter 10: LINEAR PROGRAMING
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Performance Management | Page 72 of 107
Chapter 10: LINEAR PROGRAMING
Chapter 10:
LINEAR PROGRAMING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Calculating Contribution
2
Calculating Optimal Production Plan for Maximizing Contribution
3
Calculating Shadow Price (Dual Price) & Slack
4
Extending Production beyond Existing Capacity
5
Revising Optimal Production Plan
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Performance Management | Page 73 of 107
Chapter 10: LINEAR PROGRAMING
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Performance Management | Page 74 of 107
Chapter 11: RISK & UNCERTAINITY IN DECISION-MAKING
Chapter 11:
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Performance Management | Page 75 of 107
Chapter 11: RISK & UNCERTAINITY IN DECISION-MAKING
1 Basic Terms
1.1 Risk Vs Uncertainty
1.2 Decision-making
1.3 Outcome
1.4 Variables
1.5 Pay Off
1.6 Circumstances
4 Sensitivity Analysis
4.1 Performing Sensitivity Analysis
5 Decision Tree
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Performance Management | Page 76 of 107
Chapter 12: LEARNING CURVE THEORY
Chapter 12:
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Performance Management | Page 77 of 107
Chapter 12: LEARNING CURVE THEORY
1 Learning Curve
2 Calculating Product Cost/Unit (Tabular Approach)
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Chapter 13:
FORECASTING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Scatter Graph Diagrams & Line of Best Fit
2
Coefficient Of Correlation
3
Regression Analysis
4
Calculating Regression Line Analysis
5
Adjustment for Inflation or Deflation
6
Advantages & Disadvantages of Regression Line Analysis
7
Time Series Analysis
8
Moving Averages
9
Seasonal Variations
10
Advantages & Disadvantages of Time Series Analysis
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3 Regression Analysis
4 Calculating Regression Line Analysis
4.1 Assumptions of Regression Line Analysis
8 Moving Averages
9 Seasonal Variations
9.1 Additive Model
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9.1.1 Assumption
9.2 Multiplicative Model
9.2.1 Assumption
9.3 Deseasonalisation
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Performance Management | Page 81 of 107
Chapter 14: BUDGETING SYSTEMS
Chapter 14:
BUDGETING SYSTEMS
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Uses of Budgeting
2
Preparing Flexible Budgets
3
Incremental Budgeting
4
Advantages & Disadvantages of Incremental Budgeting
5
Zero Based Budgeting (ZBB)
6
Process of Zero Based Budgeting
7
Advantages & Disadvantages of Zero Based Budgeting
8
Budgeting In Private Vs Public
9
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Performance Management | Page 82 of 107
Chapter 14: BUDGETING SYSTEMS
1 Uses of Budgeting
2 Preparing Flexible Budgets
3 Incremental Budgeting
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Performance Management | Page 83 of 107
Chapter 15: TYPES OF BUDGETING
Chapter 15:
TYPES OF BUDGETING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Importance of Principle Budget Factor
2
Sales Budget
3
Functional Budgets
4
Cash Budgets
5
Master Budgets
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Performance Management | Page 84 of 107
Chapter 15: TYPES OF BUDGETING
4 Cash Budgets
5 Master Budgets
6 Behavioural Aspects of Budgeting
6.1 Advantages & Disadvantages of Participative Style of Budgeting
6.2 Top down Vs Bottom up Approach to Budgeting
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Performance Management | Page 85 of 107
Chapter 16: BASIC VARIANCE ANALYSIS
Chapter 16:
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Performance Management | Page 86 of 107
Chapter 16: BASIC VARIANCE ANALYSIS
6 Interpreting Variances
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Performance Management | Page 87 of 107
Chapter 16: BASIC VARIANCE ANALYSIS
7 Investigating Variances
8 Reasons for Variances
9 Interrelationship between Variances
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Performance Management | Page 88 of 107
Exam Topic 17: MIX & YIELD VARIANCES
Chapter 17:
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Performance Management | Page 89 of 107
Exam Topic 17: MIX & YIELD VARIANCES
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Performance Management | Page 90 of 107
Chapter 18: PLANNING & OPERATIONAL VARIANCE
Chapter 18:
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Performance Management | Page 91 of 107
Chapter 18: PLANNING & OPERATIONAL VARIANCE
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Performance Management | Page 92 of 107
Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT
Chapter 19:
FINANCIAL PERFORMANCE
MEASUREMENT
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Assessing Financial Performance Based On Ratio Analysis
2
Divisional Performance Measures
3
Advantages & Disadvantages of Both ROE & RI
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Performance Management | Page 93 of 107
Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT
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Performance Management | Page 94 of 107
Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT
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Performance Management | Page 95 of 107
Chapter 19: FINANCIAL PERFORMANCE MEASUREMENT
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Performance Management | Page 96 of 107
Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT
Chapter 20:
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Performance Management | Page 97 of 107
Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT
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Performance Management | Page 98 of 107
Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT
6.3.1.2 Flexibility
6.3.1.3 Innovation
6.3.1.4 Resource Utilization
6.3.2 Results
6.3.2.1 Financial Performance
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Performance Management | Page 99 of 107
Chapter 20: NON FINANCIAL PERFORMANCE MEASUREMENT
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Performance Management | Page 100 of 107
Chapter 21: TRANSFER PRICING
Chapter 21:
TRANSFER PRICING
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Need for Transfer Pricing
2
Objectives of Transfer Pricing
3
Evaluating Transfer Price
4
Setting Transfer Price
5
Volume, Cost & Quality
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Performance Management | Page 101 of 107
Chapter 21: TRANSFER PRICING
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Performance Management | Page 102 of 107
Chapter 21: TRANSFER PRICING
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Performance Management | Page 103 of 107
Chapter 22: BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT
Chapter 22:
BEHAVIOURAL ASPECTS OF
PERFORMANCE MEASUREMENT
Sub Headings
S.no
Headings (click the Cross-ref below for easy navigation)
1
Performance Measurement & Human Resource
2
Manipulation of Performance Measures
3
Managerial Incentive Schemes
4
Rewarding Performance
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Performance Management | Page 104 of 107
Chapter 22: BEHAVIOURAL ASPECTS OF PERFORMANCE MEASUREMENT
9 Rewarding Performance
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Performance Management | Page 105 of 107
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