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Mahmood Reza


ACCA P5 Exam Support Notes © Pro Active Resolutions - Mahmood Reza

Page Number
Introduction 3
Examiners guidance, approach & exam 4
Exam Reports: examiners comments 7
• Strategic analysis, choice and implementation 11
• Benchmarking 11
• Risk and uncertainty 12
• Activity one 13
• Budgeting 14
• ABC, ABB, ABM 16
• BPR 19
• PESTLE and SWOT 19

• Pricing 22
• Stakeholder analysis 24

• Responsibility Accounting Systems 25

• Mission and Vision 27
• Aims and Objectives 27
• Rewards and Values 27
• The Strategic Triangle 28
• Divisionalisation and transfer pricing 28
• Activity two: transfer pricing 32
• Porter: industry analysis - the five forces 32
• Boston Box or the BCG Matrix 35

ACCA P5 Exam Support Notes 1 © Pro Active Resolutions - Mahmood Reza

• Ansoff product matrix 35
• Performance measures 36
o Return on investment (ROI) 36
o Residual income 37
o Economic value added 37
o Net present value 38
o Internal rate of return 38
o EPS 39
• Activity three: performance measures 39

• Performance management & evaluation 41
• Establishing a performance management system 41
• Criteria for designing performance indicators 42
• Types of performance measures 43
• Performance Pyramid, Lynch and Cross (1991) 43
• Balanced scorecard 45
• Table of potential scorecard measures 48

• Target costing 49
• Performance prism 50
• Total Quality Management (TQM) 50


• Activity one: solution 53

• Activity two: solution 54
• Activity three: solution 56

ACCA P5 Exam Support Notes 2 © Pro Active Resolutions - Mahmood Reza

These ACCA P5 exam support notes are based on my experience, not only in respect of
teaching ACCA P5 but over 25 years of teaching business and management. These
notes are not meant to be a comprehensive overview of the syllabus but focus on
selected parts.

The notes are provided to supplement existing texts and focus on areas that, in my
experience, students find more challenging. Any feedback regarding the notes (positive
or negative) would be greatly welcomed.

I have adopted a sectional approach to the notes, i.e. notes are provided by syllabus
section, some sectional notes being greater than others.

ACCA P5, in common with the other option papers does not enjoy significantly high pass
rates. However, people do pass the exam; a structured and focused approach to
studying is highly recommended, as well reading around the subject.

It is worth remembering that are an abundant level of support resources available to

assist you in passing your exams. However, unless you have a photographic memory
you will need to apply conventional techniques to passing your exams, e.g. question
practice, question practice, question practice – you get the picture.

ACCA Qualification
The current ACCA Qualification syllabus was first examined in December 2007; a review
of the pass rates for the option papers is shown below.
Paper Dec 07 Jun 08 Dec 08 Jun 09 Dec 2009
P4 31 36 36 30 41

P6 28 36 41 37 39
P7 33 33 39 37 39

The ACCA Professional syllabuses are being updated with effect from June 2011, these
notes are based on the existing syllabus and study guide for the December 2010 exam

The strategic planning process was examined in detail in the P3 paper. In P5 the focus
is more on the performance management aspects of strategic planning and the role of
strategic management accounting.

ACCA P5 Exam Support Notes 3 © Pro Active Resolutions - Mahmood Reza

The examiners approach article, originally produced in Student Accountant February
2007, provides guidance on how to tackle paper P5.

The examiner’s approach interview complements the approach article and is very useful
when tackling the paper for the first time, giving you a real insight into what the examiner
is looking for in terms of exam performance. It covers the main themes of the paper,
information on how the exam is structured, advice on exam technique, tips on how to
succeed and potential pitfalls to avoid.

The examiner’s analysis interview builds on the approach interview and looks at student
performance in the December 2007, June 2008 and December 2008 exam sessions,
highlighting where students are performing well, where students are performing less
well, and how they can improve their performance. The analysis interview is related to
the examiner’s reports, which are published after each exam session and are another
very useful resource.

Examiner’s approach: Paper P5

Paper P5, Advanced Performance Management, is one of four papers in the Options
module at the Professional level of the new ACCA Qualification. While not a completely
new paper, it should be remembered that Paper P5 is not the previous syllabus Paper
3.3 with a new title. Indeed, Paper P5 is a challenging and innovative paper that aims to
improve students’ understanding of performance management – a subject which
touches on all management activity in today’s business organisations.

Candidates who pass the Paper P5 exam will be able to:

Evaluate the strategic performance of an organisation and recommend
appropriate performance measures
Assess the impact on organisational performance of macro-economic, fiscal and
market factors, and key external influences
Identify the information needs of management and contribute to the development
of appropriate systems in order to improve organisational performance
Understand the significance of the relationship between financial and non-
financial indicators of organisational performance
Identify where current developments in management accounting and
performance management may be used to improve organisational performance.

As Paper P5 builds on Paper F5, Performance Management, students are expected to

have a thorough understanding of the Paper F5 syllabus. In addition, students will also
be required to apply the principles and techniques covered in Paper F2, Management

Paper P5 has a strong relationship with Paper P3, Business Analysis, in the areas of
strategic planning and control and performance measurement.

The syllabus and relational diagram

The syllabus contains six sections – designed to provide the comprehensive knowledge
necessary to enable students to make a significant contribution to today’s business
organisations. All sections are interconnected, and the syllabus, as a whole, focuses on

ACCA P5 Exam Support Notes 4 © Pro Active Resolutions - Mahmood Reza

the issues that are essential to the understanding of how performance management
contributes to organisational performance.

Section A of the syllabus focuses on strategic planning and control. This involves a
detailed examination of the role that strategic management accounting should play in
today’s organisations. This section also requires students to appraise alternative
approaches to budgeting in order to facilitate better control of business organisations.
We live in an ever-changing business environment and Section A considers the effects
of both evolving business structures and information technology on modern
management accounting practices.

Section B of the syllabus considers the impact of world economic and market trends, as
well as the impact of national fiscal and monetary policy on the performance of business
organisations. This section also explores other environmental and ethical issues facing
business organisations.

Section C is focused on performance measurement systems and their design. Particular

consideration is given to management accounting and information systems, and the
sources of internal and external information available to business organisations. In
addition, Section C considers the recording and processing methods and management
reports used in business organisations.

Section D of the syllabus is focused on the need for strategic performance management
in both public and private sector organisations. This section considers strategic
performance issues in complex organisations as well as divisional performance and
transfer pricing issues. Consideration is also given to behavioural aspects of
performance management.

Section E of the syllabus is focused on the evaluation of business performance and

corporate failure. Consideration is given to alternative views of performance
measurement and the use of non-financial performance indicators. This section also
considers the prediction and prevention of corporate failure.

Section F, is focused on current developments and emerging issues in management

accounting and performance management.

In an area as fast moving as management accounting, the importance of keeping

abreast of current developments is essential for management accountants across the


The Study Guide, which breaks the syllabus down into separate subject areas, is
available on the ACCA website.

The superscript numbers at the end of each outcome in the Study Guide indicate the
level at which students should understand a particular subject or topic area. These levels
of understanding, known as cognitive levels, are important as they indicate the depth to
which each part of the syllabus may be examined.

Because Paper P5 is at the Professional level, higher cognitive challenges –

represented by the number 3 – are prominent. This means that this paper is much more

ACCA P5 Exam Support Notes 5 © Pro Active Resolutions - Mahmood Reza

likely to use higher levels of questioning. Whereas level 1 tasks might concern
knowledge and comprehension (asking students to ‘list’, ‘define’, ‘identify’, ‘calculate’,
‘explain’, and so on), levels 2 and 3 are more demanding. Level 2 tasks concern
application and analysis (‘compute, ‘contrast’, ‘explain’, ‘discuss’, etc), and level 3 tasks
concern synthesis and evaluation. Level 3 requirements might therefore ask students to
‘evaluate’, ‘assess’, ‘design’ ‘formulate’, ‘recommend’ or ‘advise’.

It is probable that each Paper P5 exam will contain several questions at levels 2 and 3,
and the Study Guide reflects this emphasis. It is important to realise that if Study Guide
outcomes indicate that learning is required at levels 2 or 3 then it is probable that the
exam will test that area at that cognitive level. The marking scheme will reflect this fact,
and answers that do not demonstrate this higher cognitive ability will be marked
accordingly. If, therefore, a question asks a candidate to ‘assess’ or ‘evaluate’ an
argument or a statement, answers that merely ‘describe’ will not achieve a ‘pass’

The syllabus for Paper P5 aims to ensure that candidates can apply relevant knowledge
and skills, and exercise professional judgement in selecting and applying strategic
management accounting techniques in different business contexts. It also enables
students to make a significant contribution to the evaluation of the performance of an
organisation and its strategic development. Candidates should remember that Paper P5
is equivalent in standard to a Masters degree, and the emphasis is on higher-level skills.


The exam comprises two sections. Section A includes two compulsory questions usually
worth 60 marks in total; a maximum of 40 marks is available for either question in
Section A. As Section A is compulsory, candidates must not only attempt it in the exam,
but must also allocate an appropriate amount of time.

Section B contains three optional questions worth 20 marks each; candidates are
required to answer two of these questions. At least one of the questions in Section B will
require an entirely discursive answer.

In viewing the paper as a whole, the balance between computational and discursive
questions will not vary significantly from diet to diet.

There will not always be a unique or ‘correct’ solution to many of the questions that
feature in Paper P5 exams. A range of solutions will be equally valid, provided they are
supported by appropriate evidence. It is therefore important that if assumptions are
made concerning a given scenario, these assumptions are clearly stated. Some
questions may require candidates to draw on their experience, and interpret a topic
within the context of an organisation with which they are familiar.

One of the features of the Professional level exam papers is the awarding of
‘professional marks’. These are marks allocated, not for the content of an answer, but for
the degree of professionalism with which certain parts of the answer are presented.
They will usually be awarded in Section A (the compulsory part of the exam paper) and
will total between four and six marks.

It may be, for example, that one requirement asks you to present your answer in the
form of, say, a letter, a presentation, a memo, a report, briefing notes or similar. Some

ACCA P5 Exam Support Notes 6 © Pro Active Resolutions - Mahmood Reza

marks may be awarded for the form of the answer in addition to the content of the
answer. This might be for the structure, content, style and layout, or the logical flow of
arguments in your answer. You should assume that if the question asks for a specific
format of answer that some marks may be awarded for an effective presentation of that

As indicated in the syllabus, the key or core areas are:
Using strategic planning and control models to plan and monitor organisational
Assessing and identifying relevant macro-economic, fiscal, and market factors
and key external influences on organisational performance
Identifying and evaluating the design features of effective performance
management information and monitoring systems
Applying appropriate strategic performance measurement techniques in
evaluating and improving organisational performance
Advising clients and senior management on strategic business performance
evaluation, and on recognising vulnerability to corporate failure
Identifying and assessing the impact of current developments in management
accounting and performance management on measuring, evaluating, and
improving organisational performance.

In order to pass the Paper P5 exam, students should:
Clearly understand the objectives of the exam as explained in the Syllabus and
Study Guide
Ensure that preparation for a Paper P5 exam has been based on a programme
of study set for the required syllabus and exam structure
Use an ACCA-approved textbook for Paper P5. Not only are they written
especially for the syllabus, but they are also reviewed by the examiner, making
them invaluable in terms of coverage and insight into what is examinable
Practise computational, analytical, and discursive questions under exam
conditions in order to improve speed and presentation skills
Carefully study all articles that appear in student accountant (or elsewhere),
which are relevant to topics within the syllabus for Paper P5
Be able to clearly communicate understanding and application of knowledge in
the context of a Professional level exam.

Shane Johnson is the current examiner for Paper P5

This provides a useful insight into the general problems that students encounter and
extracts have been reproduced below.


Sadly, the examination revealed a large number of candidates who were inadequately
prepared for the examination. Nevertheless it was pleasing to observe that there were
far fewer candidates scoring very low marks than in recent diets and, in general, the
overall performance of candidates was much improved.

ACCA P5 Exam Support Notes 7 © Pro Active Resolutions - Mahmood Reza

Many candidates continue to display their answers poorly, with a lack of clear labelling to
indicate which questions are being attempted. Hence, many candidates would benefit by
giving more thought to the presentation of their answers. This would not only improve
the organisation of their answers but would also assist the marker by ensuring that they
commence each question on a new page within their answer booklet.

Many candidates would clearly benefit from planning their answers to discursive parts of
questions. For example, In their answers to Question 5 a number of candidates
discussed the mission statement of CFD in part (a)(i) although this was in fact a
requirement of part (a)(ii).

It was noticeable that many candidates begin their answers to discursive parts of
questions by rewriting the requirement of the question and in doing so waste valuable

Many candidates had clearly memorised solutions to past examination questions and
were determined to include them in their answers to questions on the examination
paper. Question 5 was the most common place for this to happen e.g. using a past
question on hotels as a template for dog kennels and suggesting surveying the dogs on
quality of meals and room cleanliness!


General Comments
However the examination revealed a very large number of candidates who fell well short
of achieving a pass. Indeed, there were relatively few marginal candidates at this diet.
The overall results suggest that far fewer candidates than expected were adequately
prepared for this examination.

Sadly, many candidates did not answer all of the question subsections and in not doing
so imposed limitations on the marks available to them.

Candidates should avoid the temptation to undertake ‘question spotting’. The P5

examination paper continues to examine the full syllabus and as such will continue to
reveal those candidates who are poorly prepared. That said there was still much in this
examination that was consistent with previous examination papers (Questions 1, 2 and
4) which should have given the more able and prepared candidates a sound foundation
for success.

Candidates need to be aware whether they have the knowledge to answer discursive
questions. If they do not then it is essential that they realise that the quantity of work
produced is not a substitute for quality. This was particularly evident from candidates’
answers to Question 3.

Workings were generally shown but were at times difficult to follow. Many candidates
continue to display their answers poorly, with a lack of clear labelling to indicate which
questions are being attempted. Each question should be started on a new page and
candidates must give more thought to the layout and organisation of their answers. This
is especially the case given the potential to earn professional marks in this or any other
of the professional level examination papers.

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One major problem was candidates ‘memorising’ model answers to past paper
questions and attempting to ‘shoehorn’ these answers into questions without even
attempting to adapt these answers to the question context.

Question 2(d) provided cases of this practice. The question clearly asked for
performance measures to assess the quality of service of a software provider, yet there
were answers such as ‘the quality of meals, waiting time at reception, staff uniforms and
cleanliness, as well as specific mention of hotels. This practice was also evident from
candidates’ answers to Question 4(b) with many different organisations mentioned and
only the minority of candidates actually referring to BAG.

Also evident was the inability of many candidates to interpret the numbers and ratios and
translate them into ‘good’ and ‘bad’, even things such as a ‘lost items percentage’ being
higher than the target was seen as constituting good performance simply because the
number was higher! This suggests that candidates are taking a rote-learning approach
which is inappropriate for this level of examination.


Many candidates did not answer all of the question subsections and in not doing so
imposed limitations on the marks available to them.

The consensus of opinion from the marking team was that the paper provided the
opportunity to obtain relatively high marks. However, the examination revealed a large
number of candidates who performed poorly. The overall results for this diet were not


Sadly, the examination also revealed a large number of candidates who seemed
inadequately prepared for the examination. Nevertheless it was pleasing to observe that
only a relatively small number of candidates scored very low marks. In general, the
overall performance of candidates was good.

Many candidates who clearly had knowledge of the areas of the syllabus which featured
within the examination questions were unable to achieve a pass at this diet as a
consequence of poor examination technique which frequently manifested itself via poor
presentation and/or time management or not observing the specific requirements of
each question.

Well-prepared candidates invariably provided concise workings which arrived at the

correct solutions to the computational parts of the examination paper. However, a
significant number of candidates produced workings, notably in their answers to part (a)
of Question 1, which were and difficult to follow. The need for candidates to give more
thought to the layout and organisation of their answers is of paramount importance. This
is especially the case now that ‘professional marks’ might be awarded for well-
presented answers.

Rather surprisingly, a number of candidates ignored the advice given in previous

examiner’s reports that each question should be started on a new page in their answer

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booklet(s) and that there should be clear labelling to indicate which questions are being

It was pleasing to observe that the vast majority of candidates attempted all four
questions. However, there was some evidence of poor time management, particularly
affecting Question 1 which a significant number of candidates attempted as their final

The poor performance of many candidates was exacerbated by a clear failure to

carefully read the content and requirements of questions. This contributed to some poor
performances in both the computational and discursive parts of questions.

ACCA P5 Exam Support Notes 10 © Pro Active Resolutions - Mahmood Reza

Strategic analysis, choice and implementation

Johnson and Scholes’ 3stage model of strategic planning is a useful framework for
seeing the ‘bigger picture’ of performance management and strategic management
accounting issues.

The term ‘strategic management accounting’ refers to the full range of management
accounting practices used to provide a guide to the strategic direction of an organisation.

Strategic management accounting gives a financial dimension to strategic

management and control, providing information on the financial aspects of
strategic plans and planning financial aspects of their implementation.
It supports managers throughout the organisation in the task of managing the
organisation in the interests of all its stakeholders.
Strategic management accounting places an emphasis on using information from
a wide variety of internal and external sources in order to evaluate performance
appraise proposed projects and make decisions.
It focuses on the external environment, such as suppliers, customers,
competitors and the economy in general as much as on the organisation itself.
Strategic management accounting monitors performance in line with the
organisation’s strategic objectives in both financial and nonfinancial terms

Benchmarking is the practice of measuring an organisations products or services against
“best practice”; the primary objective is to improve processes or activities. Through
benchmarking, organisations learn about their own practices and procedures, and the
best practices of others. Benchmarking enables them to identify where they fall short of
current best practice and determine action programmes to help then match and surpass

Benchmarking originated in the USA in the 1970s, pioneered by Rank Xerox and was
‘exported’ to Europe and the UK in the 1980s. A number of commercial, public sector
and not for profit organisations have successfully embraced the technique, and it is a
popular and effective management process.

Any activity that can be measured can also be benchmarked. However this is neither
feasible nor practical. The starting point for any benchmarking exercise is to determine
the key performance areas; those are the areas that are critical to the organisation,
operationally and strategically. They should focus on those areas that (a) tie up most of
the resources; (b) significantly improve the relationship with their client groups; (c)
impact on the viability of the organisation. For example a charitable organisation that
relies on grant aid as its main source of income might benchmark fund raising activities.

Once the key performance areas have been decided upon an organisation must then set
the key standards and variables to measure, these are commonly known as “key
performance indicators” (KPIs). Having defined the benchmarks the hunt is on for
information to establish the benchmark performance. There are four types of

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Internal: this is done within an organisation arid generally between closely
related divisions, plants or operations. This is an easy way to start benchmarking, but is
limited to internal criteria only
Functional: this is a comparison of performance and procedures between similar
functions, but in different organisations and industries. It is more likely than internal
benchmarking to generate benefits to the specific function, but it is unlikely to give wide
benefits throughout the organisation
Competitive: this focuses on direct competitors within the same industry and
with specific comparable business operations, or on indirect competitors in related
industries with complementary business operations. There can be practical difficulties in
achieving this.
Generic: this is undertaken with external companies in different industries that
represent the "best-in-class" for particular aspects of the selected business operations.

Organisations then need to specify programmes and actions to close the gap. Having
measured one’s actual performance and compared it with some form of target,
benchmarking moves from simple measurement through to performance improvements.
Many organisations forget this stage and therefore miss the real benefit of
benchmarking. It is essential that programmes and actions are implemented and that
ongoing performance is monitored.

Successful and effective benchmarking requires commitment and support from the
board and senior management. Managers need to be as specific as possible when
identifying areas to benchmark. For example, a company that wishes to benchmark
customer service needs to decide what specific aspect of customer service needs to be
examined. Customer service encompasses a diverse range of activities, such as
dealing with enquiries, handling disappointed customers, issuing refunds and taking
payments. Each of these activities is different, each with its own thought processes,
techniques and controls.

Once the best practices have been identified, the benchmarking team collects the data,
analyses it, and then plots their performance against best practice to help identify
improvement opportunities.

Finally the team decides what is needed to adapt the best practices to suit their own
particular circumstances, this will a re-evaluation and re-design of existing procedures
and approaches. A cost-benefit exercise will usually be carried out and an
implementation timetable with priorities is established.


Risk management is the process of managing your organisation's exposure to potential
liabilities. It gives managers, staff, clients, the board and other stakeholders the
confidence to pursue their mission without the fear of legal action or harm, and
approaches risk in a structured and calculated manner, rather than being haphazard.

Risk consists of three elements, namely choice, likelihood and consequence. Some
choice is needed in the situation, if there is no choice, a manager does not have a risky
situation a rather a bounded one beyond the manager's control; Likelihood infers some

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level of uncertainty; and some unwanted consequence must exist in one or more of the
choices available to the manager.

Decisions under uncertainty are effectively where

• Outcomes are known
• Associated probabilities are unknown

Decisions under risk are effectively where

• Outcomes are known
• Associated probabilities are known

A number of techniques exist for decision making under uncertainty, the more popular
being contingency tables and its associated interpretation:

Contingency Table
This is used for decisions made under uncertainty; it identifies & records all payoffs
where action affects outcomes.

This maximises the smallest pay-off, it is indicative of a pessimistic and Risk-averting

This has the highest maximum pay-off, it is indicative of an optimistic approach, albeit
with the risk of loss to low returns

Minimax regret
This minimises the maximum possible regret and limits the potential ‘opportunity’ loss.
Regret is seen as the pay-off lost v. not pursuing optimal action

Expected Values (EV)

This is used where decisions subject to risk

EV = Total of probabilities of outcome × returns

A retailer needs to decide how many kilos of fruit he needs to buy from the market and
has assessed the possible daily demand as 60, 100, 125 or 175 kg

He can buy quantities of 50, 100, 150 or 200 kg at a price of £4 per 10 kg. The selling
price is £1 per kg with any unsold apples being scrapped.


a) Construct a contingency table

b) How many kilos should be bought if the following approach were adopted?

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c) Calculate expected contribution (EV)

Budgets have multiple functions, namely
Management produce detailed plans for implementation
Actions of different parts of organisation are brought together
Everyone is informed of the plans and policies; top management communicates
to lower level management
This influences managerial behaviour, individuals motivated to perform in line
with objectives. This can encourage inefficiency and conflict between managers
Assists managers in controlling activities with managements attention
concentrated on deviations from a pre-set plan
Performance Evaluation
Measuring success of achieving the budget, rewards like bonuses are given in
some companies and is meant to iinfluence human behaviour

Incremental budgeting
Indirect cost and support activities are prepared incrementally

Zero based budgeting

Activities are justified & prioritised before decisions are taken. The approach is that
‘budgeted’ expenditure starts from base zero and description of each activity is included
in a decision package, they are evaluated, ranked and resources allocated.
The benefits are that the deficiencies of traditional budgeting are avoided, resources are
allocated by need or benefit; a questioning attitude is created and the focus is on
attention on outputs in relation to value for money

Anthony (1965) categorised control into three main types:

Strategic Control
The setting of corporate strategy and long term objectives for the organisation.

Operational Control
Operational control is ensuring that specific tasks are carried out. This is primarily
concerned with the processing of inputs and raw materials to get outputs.

Management Control
Management control is the coordination of the day to day activities in an
organisation to ensure that inputs and raw materials are used efficiently and
effectively towards achieving long term goals. Management control, therefore,
links strategic control and operational control.

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Management control utilises regular feedback reporting systems so that corrective action
can taken where variances from plan are identified. The budget plays an important role
here in providing controls to aid management control.

The systematic comparison of planned inputs to actual results made using the budget,
followed by corrective action where deviations from plan exist, is known as a ‘control
system’. The system providing the reports for this control system is known as
‘responsibility accounting’. This will be discussed in more detail later in the session.

Feedback and Feed-forward Controls

Feedback control - occurs where actual outputs are monitored against desired
outputs and corrective action is taken where there is a variance between the two.
Feed-forward control – predictions are made about future outputs and
compared to desired outputs and action is taken where there is a difference
between the two.

So, with feed-forward controls any likely errors can be foreseen and actions taken to
avoid them, whereas, with feedback control actual errors against the plan are identified
and corrective actions taken to achieve the remainder of the plan.

The budgeting process is an example of both a feed-forward and feedback control


Budgets as feed-forward control

In putting budgets together, and submitting them to the budget committee, they are
compared against the future expectations of the organisation as outlined in the long term
plan. If the budget falls short of these expectations then it may be adjusted and
alternatives considered. This process may continue until a budget is agreed that will
meet long term expectations.

Budgets as feedback control

During the budget period actual results are compared to the budget and any deviations
from budget identified. Corrective actions are then taken to ensure that future results are
in line with the budget.

Budgets have conflicting roles and a single budget system can’t serve several purposes
with planning and motivating roles potentially in conflict.

The traditional budgeting model has been criticised for its dysfunctional impact on
performance improvement, design and decision making. This was highlighted by Hope
and Fraser in their article "Beyond Budgeting" which won the prestigious IFAC award for
best management accounting article of 1998.

Beyond budgeting is an alternative management model based on the decision-making

needs of front line managers. In the model, the nature of performance responsibility is

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transferred from the centre. Work place culture has a significant impact on the
successful implementation of beyond budgeting; it is the participation in decision-making
and authority (according to Hope and Fraser) to use their own judgement and initiative
that motivates employees to act in the best interests of an organisation and its

Beyond budgeting requires goal setting, rewarding employees, planning action,

resources and co-ordination. Goal setting needs to base targets on KPIs and relative
benchmarks to ensure that managers pursue strategic and financial goals. Medium
term goals typically include financial performance expectations, wastage reductions, new
product introductions and customer satisfaction ratings. Setting targets based on internal
and external benchmarks helps remove internal political negotiations.

Managers' performance bonuses can be linked to KPIs both at corporate and business
unit level.


Organisations are typically structured hierarchically on a functional basis and costs are
typically reported, and control exercised, under commonly recognised general account
headings. Within this system, departments are controlled against budget and past
performance. This is a well tried and well understood approach but it fails due to

1. Senior management focusing effort on corporate strategies but failing to

communicate them down the organisation to the lower levels. Businesses try to
meet their corporate objectives and to meet the needs of their customers. However
with each department having its role to play in a cost budget, the departments often
allow budgetary targets to dominate. Their contribution to meeting business and
customer needs is neglected.

2. Conventional cost management fails to recognise that corporate success depends

on the effectiveness of its key business processes. Such processes frequently cross
departmental boundaries. Inadequacies, in any department which contributes to a
business process, can affect the entire organisation which is only as strong as the
weakest link. Traditional management accounting and financial control systems
reflect the needs for a hierarchical function in the organising structure. They do not
recognise or support the effectiveness of the key business processes.

Customer Profitability
The needs of customers can vary radically. In their efforts to retain existing customers
and attract new ones, companies can be drawn into providing widely different levels of
service in respect of many different service elements such as frequency of delivery,
number of order lines, quantity per order line, customer location, discounts given,
salesmen's visits and special orders.

These have one thing in common, they all have associated costs. Conventional cost
accounting techniques rarely recognise them. As a result companies do not know the
true cost of trading with these customers, or even with customer groups. Certain
customers may attract so much cost that they provide no profit contribution at all. In
addition, companies may be unaware of the true value their customers place on the level

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of service they provide. Under such circumstances, companies may be trading at a loss
with certain customers, giving them a costly service which they do not actually require.

ABC is one answer in view of the drawbacks of conventional cost management.

The ABC approach recognises the following -

The need to generate product costs that more accurately reflect the factors
which drive them, such as variety and complexity - not just volume.
The requirement to attribute the cost of differing levels of service to your
customers in order to establish true customer profitability.
The need to be able to measure the cost of failure throughout the
organisation, particularly in the overhead functions, so as to focus
management attention to the major opportunities for improvement.
The need to identify the factors that drive costs and helps guide managers as
to where they can best direct their efforts in order to control costs.
The crucial importance of the key business processes.

The idea behind activity based budgeting is to develop an activity model (or series of
linked cost centre activity models) of resource requirements. This model can then be
flexed to affect different volume assumptions which may need to be evaluated after the
first stage of the budgeting process (external assessment). It can also be used as a
basis for identifying and producing performance improvement. Once the final budget
model has been agreed, it then forms the basis for management control through
variance analysis with a more complete understanding of the impact of changing
volumes on activity resource requirements.

In developing the activity based budgeting model it is important to understand and


What activities are being/need to be carried out?

How efficiently the activities are being carried out and to what quality and
What is driving the level of resource required to perform this activity (the
activity level volume driver).
The relationships between the activity level volume driver and its root cause.
How the root cause may be changed and how this can affect the activity
resource required.

Activity based budgeting can take this a stage further by identifying and modelling a
cascade of activity level volume drivers. For example, in order to achieve a target sales
volume, an organisation needs to process so many orders which will result in so many
invoices with so many complaints and queries to handle before the transactions can be
completed. Each of these activity level volume drivers carries with it a unit cost that can
be used to calculate the total value of the resources required.

Understanding these cost linkages is vital to a good understanding of cost behaviour and
this is at the heart of activity based budgeting. However, this understanding is not fully
exploited unless management can use it to make changes in the way the organisation

ACCA P5 Exam Support Notes 17 © Pro Active Resolutions - Mahmood Reza

goes about its business. The most significant of the cost beneficial changes can only be
made if incorporated into budgets through discussion and performance reviews.

The determination of the cost of a product or service is vital at the strategic planning
level, as it is at the operational level. For example, organisations may need to evaluate
the market profitability and should they remain in it?

However the customer will perceive things from his/her own perspective. Essentially this
will involve making decisions about the value of the service or product to them compared
to its cost. Using a customer perspective for managing the business implies that
management will have to concern itself with some or all of the following issues:
How does the customer perceive the quality of our product versus that of our
How can we continuously improve?
Do the activities undertaken by the company produce the value that the customer
requires - activity analysis?
What are the costs of these activities and are they being carried out efficiently?
How well are the activities/processes being performed relative to competitors?
What are the important things that we should be controlling?

Because the basis of this concern rests on the activities carried out this is called activity
based management.
In order to determine the cost of each activity it is necessary to determine how time is
spent and how costs build up. For example the profitability of a customer will depend not
only on the price and costs of the products purchased, but also on such factors as the
number of orders placed in a year, the number of calls made on the technical service
department and so on. This means that costs will have to be traced to this customer
from all over the company, not just the plant. This is done through cost drivers.
Cost drivers are those elements that give rise to the need for an activity such as the
number of orders for a sales order department, number of complaints for the customer
service department and so on. While there may be many identifiable cost drivers
management will need to identify the minimum set that will allow the costs to be
Cost drivers apply at different levels:
Unit level
Number of hours required to produce a product
Batch level
These are costs such as machine set-up or inspection, these occur once per
Processor product level
These cover such items as engineering change orders which refer to a product or
Organisation level
They are incurred for supporting the continuing level of operations i.e. building
depreciation, division managers’ salary.

ACCA P5 Exam Support Notes 18 © Pro Active Resolutions - Mahmood Reza

This is often referred to by the acronym BPR and one of the ways that organisations
aspire to become more efficient and effective. Business Process Re-engineering (BPR)
is the strategic analysis of business processes and the planning and implementation of
improved business processes.

A key element underlying the BPR philosophy is that one should look at an organisation
as a series of processes, as opposed to functional specialties such as production, and
marketing. The approach advocated by Davenport (1992) is to
1. Develop the business vision and process objectives
2. Identify the business processes to be redesigned
3. Understand and measure the existing processes
4. Identify IT levers
5. Design and build a prototype of the new process
6. Adapt, if appropriate an organisations organisational structure and governance

BPR is not a universal panacea and criticisms of the approach include

Ineffectiveness of processes is what limits an organisations performance, this is

not necessarily true
The existing way of doing things is disregarded
No real focus is provided for process improvement on organisational constraints
The model (US origin) may be culturally biased towards a US perspective;
cultural differences make it difficult for this approach to be universally applicable.


One of the key features that differentiated strategic management accounting from
traditional management accounting is the external focus. By looking at the
organisation’s competitive position we will be concentrating on this external focus

The business environment can be thought of as comprising the wider macro-

environment and the competitive (operating) environment

ACCA P5 Exam Support Notes 19 © Pro Active Resolutions - Mahmood Reza


Your Social
Political Organisation Entrants




The figure above shows the range of environmental influences. It is useful to identify
what macro environmental factors are affecting an organisation and then to consider
which of these are most important (a) at present, (b) in the future. This is known as a
PESTEL analysis, i.e. an assessment of how Political, Economic, Social, Technological,
Ecological and Legal factors impact, or are likely to impact, on your company.

A mere listing of PESTEL influences has little value, it is important to identify the key
opportunities and threats facing the company (a) at present, (b) in the future and how
these are, in effect drivers for change. A PESTEL analysis should also examine the
differential impact of these macro environmental influences by asking how they affect
different companies differently. Some form of impact analysis and scenario planning is
especially useful to explore different possible futures. This exercise allows “what if”
questions to be explored.

This is a strategic planning tool which summarises the key issues from the business
environment and the strategic capability of an organisation most likely to impact on
strategy development. This can be used as a basis against which to generate strategic
options and assess future courses of action.

STRENGTHS: What we are good at

WEAKNESSES: What we are not so good at
OPPORTUNITIES: Favourable events trends
THREATS: Unfavourable events trends

ACCA P5 Exam Support Notes 20 © Pro Active Resolutions - Mahmood Reza

The primary aim is to identify the extent to which the current strengths and weaknesses
are relevant to and capable of dealing with the changes taking place in the business
environment. If the strategic capability of an organisation is to be understood the SWOT
analysis is only considered useful if it is comparative, and not absolute to its
“competitors” or other organisations, i.e. examining strengths, weaknesses, opportunities
and threats relative to competitors.

A SWOT analysis should help focus discussion on future choices and the extent to
which an organisation is capable of supporting these strategies. An effective SWOT
should be limited to four to five factors, focus on major and not marginal areas, be open
and honest and have a priority and emphasis.

ACCA P5 Exam Support Notes 21 © Pro Active Resolutions - Mahmood Reza


There are three general approaches to pricing

Market based approach, which includes

Target pricing
Market skimming
Price differentiation
Competitive pricing
Cost based
Cost plus
Economic approach


The actual approach to be adopted will be influenced by the stage in the product life
cycle and general market considerations such as

Company’s Market Position

The nature of the market & its share
Whether the company is price setter or price taker
The likely competitor reaction

The Macro-Economic Status

Is the economy experiencing boom, recession or confidence?

Other Aspects of the Marketing Mix

The product mix
Any constraints of range
Are there bundling opportunities
Product / service attributes

Unit Selling Price = Variable Cost + % contribution
Normally used for short-run tactical or scarce resource situations
A danger that low prices become norm

Unit Selling Price = Total Cost / Budget Volume + % Profit
This ensures that profits are above break-even volumes
There is a risk of a spiral of declining demand

Unit Selling Price = Incremental (cash) Costs only

ACCA P5 Exam Support Notes 22 © Pro Active Resolutions - Mahmood Reza

or opportunity costs in a scarce resource situation

This is considered a theoretical approach to pricing for products exhibiting elastic
demand, these being ones that are
Has no distinctive USPs (Unique Selling Proposition)
Product substitutes exist
That there is no perceived value in the product
A strong correlation between price and demand, i.e. a % increase in price causes
a corresponding % decrease in demand (and vice versa).

Profit Maximisation occurs where marginal revenue = marginal cost, this can be
determined by graphical interpretation, tabulation, or differential calculus

The calculus approach effectively involves solving the equation of a straight line, where
P is known as the dependent variable and Q is the independent variable.

P= a - bQ
P = Price; a = Constant (Intercept); b = Gradient; Q = Quantity


b = is the gradient for demand curve and = Change in price

Corresponding change in qty demanded

Marginal revenue is the increase in total revenue from the sale of one additional unit
Marginal cost is the increase in total cost when output is increased by one additional unit

1. Establish cost function
TC = FC + Q×VC
TC = Total cost; FC = Fixed cost; VC = Variable cost; Q= Demand

2. Establish revenue function

ACCA P5 Exam Support Notes 23 © Pro Active Resolutions - Mahmood Reza

Establish maximum selling price
Revenue = P × Q; P = Selling Price; Q = Demand

3. Establish marginal cost and differentiate cost function

4. Establish marginal revenue and differentiate revenue function

Optimum selling price is where:

Marginal cost = Marginal revenue

Stakeholders are normally seen as individuals or groups that are affected by
organisations activities, these consisting of providers of finance, managers, employees,
competitors, government, clients and suppliers.

It is important to conduct a Stakeholder Analysis, as the most powerful stakeholders are

the ones who ultimately determine the purpose and direction of the organisation. It may
be easy to assume that the owners of an organisation as the most powerful
stakeholders, however, this is often not the case and so the leader in an organisation
should have a clear view of where the most powerful influences are likely to come from.

Stakeholder Analysis is a process that involves the following stages:

Identify - who are the stakeholders?

Assess and rank - which stakeholders have the most power or influence over the
Decide criteria - what are the stakeholders’ expectations?
Decide actions - are we meeting the stakeholders’ expectations? If not, what
should we do?
Assess performance - are our actions on generating the appropriate outcomes,
or should we change?

One analytical tool way to help manage stakeholders is Mendelow’s Matrix.

Low A B
Stakeholder power
High C D
A. Minimal effort; Low High
Probability of exercising
B. Keep informed;
power/level of interest
C. Keep satisfied;

D. Key players.

ACCA P5 Exam Support Notes 24 © Pro Active Resolutions - Mahmood Reza

Responsibility accounting systems identify individual areas of responsibility in the
organisations structure. Each area of responsibility is often referred to as a ‘responsibility
centre’. Managers are allocated responsibility centres and held responsible for its

There are four types of responsibility centre:

1. Cost Centre – managers are responsible and accountable for costs only
2. Revenue Centre – managers are responsible and accountable for revenue only
3. Profit Centre – managers are responsible and accountable for both revenues
and costs
4. Investment Centre – managers are responsible and accountable for revenue,
costs and capital investment decisions

In operating a responsibility accounting system a number of issues have to be


Controllable and uncontrollable costs

Managers should only be judged and measured on costs and revenues that they
control. If a manager is allocated responsibility for uncontrollable items then no
matter what variances occur for that item the manager will not be able to take
actions to correct the situation. This only serves to demotivate the manager

Problems of dual responsibility

It may be for some items an element of shared responsibility exists. For example,
direct labour may be the responsibility of the production manager. However,
training courses for direct workers, which may require overtime payments for
attendance, may be the responsibility of the human resources manager.

In these instances a responsibility accounting system should seek to assign and

report on cost to the person having ‘primary’ responsibility.

Guidelines for reporting

1. If a manager can control the quantity and price paid for a service or goods
then the manager is responsible for all of the expenditure incurred for that
service or goods.

2. If a manager can control the quantity of the service or goods but not the
price paid for that service or goods then only the variance in usage should
be attributed to that manager.

3. If a manager cannot control either the quantity or price paid for a service
or goods then both usage and expenditure are uncontrollable and should
not be attributed to the manager.

Arbitrary costs

ACCA P5 Exam Support Notes 25 © Pro Active Resolutions - Mahmood Reza

Generally costs, such as insurance, heating and rent are apportioned to cost
centres on some sort of arbitrary basis, e.g. floor area. For managers operating
in a responsibility accounting system this would render them uncontrollable.
Therefore, managers should not be held responsible for them.

However, if managers do not see these costs then they will not understand the
costs that are incurred to support their business areas. There is an argument,
therefore, that managers should be made aware of arbitrary costs. This would
prevent the abuse of services, such as IT support. It should also be borne in
mind that they may have some influence on the costs involved.

ACCA P5 Exam Support Notes 26 © Pro Active Resolutions - Mahmood Reza

The expressions Vision and Mission are used to describe aspects of organisational
purpose. They serve to explain the concept of organisational purpose in order that
managers may better understand and be able to apply it.

A mission statement is a statement of the overriding direction and purpose of an
organisation. It is the foundation for any strategic plan and expresses its “reason for
being”. A mission statement is the foundation for the entire strategic planning process. It
sets the standard to which the organisation aspires, now and in the future, and forces
the Board members and staff to align themselves around a specific agenda.

A statement of what the organisation will be, or be perceived to be. It often includes
references to products and services, customers, markets, employees, new technology
and social responsibility.

The term vision statement is used by some organisations instead as mission statement,
vision and/or value statements may also be developed alongside the mission statement.

These normally flow from the mission statement and are subsequently used to develop
suitable organisational objectives. Organisational and strategic aims represent the link
between mission and objectives and act as a statement of intention. They tend to be
positive in nature and unquantifiable, unlike objectives.

Objectives are statements of specific outcomes that are to be achieved, from the
strategic to operational levels. Objectives are developed and extended from an
organisations mission statement and goals; they can be stated in financial and non-
financial terms. Conventional wisdom is that unless objectives are SMART (Specific
Measurable Attainable Relevant Time Bound) then they are not helpful, however, some
organisational objectives are important but difficult to quantify or convert into measurable
terms, such as to be the leader in ones field. Milestones and indicators of achievements
are essential to monitor progress of all objectives.

What we can expect as a result of our efforts. Rewards can be either financial or non-
financial. In most instances a mix of both and non-financial rewards will be expected.

Those things that we believe to be important, and if they were not met, or respected,
would cause us to be unhappy.

ACCA P5 Exam Support Notes 27 © Pro Active Resolutions - Mahmood Reza

The Strategic Triangle



Mission Rewards

As a business expands it eventually reaches the stage where it becomes appropriate to
split it up into smaller, more manageable units – to decentralise. Reasons may include:

Size – a large organisation with centralised management become unpractical

Nature of work – specialists become necessary to deal with the diverse and
complex activities of a business
Motivation – managers need incentives to perform well
Uncertainty – volatile market conditions are better coped with by a manager with
a smaller, closer, sphere of influence
Geographical – it is important to get close to markets and sources of supply
Fiscal – profits can, subject to legal restrictions, be diverted in such a way as to
minimise tax liabilities

It may well be the case that some degree of decentralisation arises as a result of the
way in which a business expands. If the expansion is by take-over of companies that
then become subsidiaries within group, a decentralised structure automatically arises.

One condition for a successful decentralisation is that the various divisions should be
more or less interdependent of each other. However, in practice, this is unlikely to be
the case and a certain amount of inter-divisional trading will take place. A transfer
pricing policy is needed if goods and services are passed between divisions.

Two of the main organisational structures are functional or divisionalised, represented as


ACCA P5 Exam Support Notes 28 © Pro Active Resolutions - Mahmood Reza



Transfer pricing deals with the problem of pricing products or services sold (Transferred
within an organisation). Decisions over suitable transfer prices are needed if a firm has
split itself into autonomous units i.e. it has decentralised or is involved in setting prices
between connected companies in different countries.

The approaches to setting transfer prices are similar to those for external sales, there
are cost-based methods and market based methods. At first sight it would seem that
setting prices for internal transfers is less critical than for external sales; however it has
to be appreciated that the divisions into which a large group will split itself expect to act
as self-contained units. The decision over transfer pricing is even more critical since top
management is in a position to identify whether it is more economical for a product or

ACCA P5 Exam Support Notes 29 © Pro Active Resolutions - Mahmood Reza

service to be bought and sold internally or externally, but at the same time needs to take
into account behavioural considerations such as the motivation of divisional managers.

It might appear that the credit to the supplying division is merely offset by an equal debit
to the receiving division and that therefore, as far as the whole organisation is
concerned, it has a net zero effect. This is true in terms of the physical application of a
transfer pricing system once it has been decided upon and implemented. However,
there are important behavioural and organisational elements associated with transfer
pricing and the choice of which method to adopt. The transfer price does affect the profit
of each division separately and, therefore, can affect the level of motivation of each
divisional manager.

Adopting a transfer pricing policy will result in:

• Total corporate profit to be divided up between divisional profit centres, it may result
in a cost centre being converted into a profit centre
• Information becoming available for divisional decision-making
• Information being made available to help assess the performance of divisions and
divisional managers

The rules for the operation of a transfer pricing policy are the same for any policy in a
decentralised organisation. A system should be reasonably easy to operate and
understand as well as being flexible in terms of a changing organisational structure. In
addition there are four specific criteria which a good transfer pricing policy should meet:
• It should provide motivation for divisional managers
• It should allow divisional autonomy and independence to be maintained
• It should allow divisional performance to be assessed objectively
• It should ensure that divisional managers make decisions that are in the best
interests of the divisions and also of the company as a whole.(goal congruence)

Setting the transfer price

In the majority of cases the transfer price will be set somewhere between these two
extremes. It is important that the criteria used to pick a price are easy to understand and
that the impact of the price on the profits of the two segments can be easily evaluated.

The difference between the upper and lower prices represents the corporate
profit/savings generated by producing the product or service internally. The chosen price
“divides” the profit between the two segments. For external reporting this is irrelevant
since the profit element will be eliminated when the financial statements are
consolidated. However this division of profits may be extremely important for internal
reporting since it affects the results of the responsibility reports and hence the success
or failure of the segment.

There are three main methods used to set the transfer price.

Cost-Based Transfer Prices

The big problem with cost-based prices is deciding on the cost to be used. Is it to be an
actual or standard cost? Will it be fully absorbed cost or variable cost and if so what will
be included? Will there be additional elements to cover general and administrative costs
for example?

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If actual costs are used then the cost may vary according to the season or according to
the efficiency of the supplying segment and the receiving segment will have no idea how
to set its sales prices. What additional costs are included and are they reasonable or
have they been inflated?

Market-Based Cost
Market pricing is believed to be an objective arm’s length method of arriving at a transfer
price. If a supplying segment is operating efficiently it should be able to make a profit at
this price. Similarly if the receiving segment is operating efficiently it should be able to
make a profit since it would have to purchase at this price if the item was not
manufactured internally.

However several problems may exist in practice. First market price may not be
appropriate because internal production should lead to savings in bad debt, delivery and
marketing expenses. The product or service may not be available on the open market. If
the market price is temporarily depressed or increased due to events beyond the control
of either segment which price should be taken, the normal or the temporary? Finally, in a
market, discounts on price are ordinarily given when volume orders are placed or long-
term contracts are signed. Finally the market price may not equal the LRMC and in this
case the company will fail to set it price/output decisions correctly, although this is less
true of commodity products.

Negotiated Transfer Prices

Some companies allow business segments to negotiate the transfer price, usually
between the upper and lower limits set out above. There is an implication here that the
buying segment has the right to purchase form external sources if it cannot agree a
price. Such freedom runs the risk of sub optimisation as segment managers’ fight to
gain the lion’s share of the available profit. For this reason the company may specify
arbitration processes and for performance management purposes may evaluate
managers on the basis of the total profit made by both segments, irrespective of the
segment n which they work.

Dual Pricing
To overcome these problems companies can adopt the practice of dual pricing. Here the
agreed transfer price is used only for the purposes of financial reporting of individual
segment results. For management evaluation purposes the variable or absorbed cost is
applied to the results of one or both segments. The difference between the “entity” and
management price is called the “mark-up”.

The mark-up is accounted for by assigning it to a different account that is used for
reconciliation purposes. That is to say the amount of mark-up in the buying segment’s
accounts must equal the amount of mark-up in the selling segment’s accounts. This
reconciliation is the same as is done for the purposes of consolidation of the accounts.

Using dual pricing allows a company to get the best of both worlds. The transfer price
can be set to meet the regulatory and corporate finance constraints while the price used
by local management can be based on a close approach to the economist’s long-run
marginal costs so allowing the company’s global operations to optimize their third-party
pricing and output decisions on a decentralized management basis.

ACCA P5 Exam Support Notes 31 © Pro Active Resolutions - Mahmood Reza

Receive Inc. and Provide Inc. are trading subsidiaries of the Happy Group of companies.

Receive Inc. manufactures a branded product sold in containers at a price of $30 per
container; the following cost information has been obtained.
Its direct product costs per container are:
Raw materials from Receive Inc. at a transfer price of $14 per container.
Additional processing costs at of $5 per container.

Receives monthly fixed costs are $60,000, a market research study has indicated that
Receive Inc. could increase their market share by 75% in volume if it were to reduce its
price by 20%.

Provide Inc. produces a standard product which can be converted and used for a
number of final products. It sells one quarter of its output to Receive Inc. and the
remainder to customers outside the group.

The production capacity of Provide Inc. is 52,000 containers per month, but competition
is tough and it plans to sell no more than 36,000 containers per month for the year
ending 31st March. Its variable processing costs are $7 per container and its monthly
fixed costs are $80,000 per month.

The Happy Group’s transfer pricing policy is to use market prices, where known.

a. Calculate the monthly profit position for each of Provide Inc. and Receive Inc. if
the sales Receive Inc. are
(i) At their present level, and
(ii) At the higher potential level indicated by the market research, subject to a
cut in price of 15%.

b. Recommend, with supporting calculations, a possible transfer price.


The factors that determine the returns that are possible in an industry are known as the
Five Forces. This approach to analysis was developed by Prof. Michael Porter
(Competitive Strategy, 1980) initially as an investor’s tool. An industry is a group of firms
producing products that are close substitutes for each other. According to Porter five
forces determine industry structure:
1. Buyer Power
2. Threat of substitutes
3. Supplier Power
4. Rivalry
5. Barriers to Exit and Entry.

Competition in an industry continually works to drive down the rate of return towards the
competitive floor rate of return.

ACCA P5 Exam Support Notes 32 © Pro Active Resolutions - Mahmood Reza

Threat of

Bargaining Power of
Power of Your Buyers
Suppliers Organisation (customers)

(Supply conditions) (Demand conditions

– across total
market / segments)

Threat of

Buyer Power
Buyer power is the ability of the buyer to determine the price at which they will buy
irrespective of the decisions of the firm.
A group of buyers is powerful if for example a buyer purchases large amounts
relative to the seller’s total sales.
If the product bought represents a significant portion of the buyers total
purchases the buyer will tend to shop around for lower prices.
If the products are standard and undifferentiated the buyer will have more power
over prices.
If the buyer has few switching costs it will not be locked into a particular seller.
If the buyer has low profitability it will have to press for low prices.
If the product is unimportant to the quality of the buyers products or services.
If the buyer can exercise significant power over which products its customers
purchase as in large retail stores.

Substitute Products
Firms in one industry are also competing with firms in another that produce substitute
products. Substitutes limit returns in an industry by setting a ceiling on the prices the
industry can charge. The more attractive the price-performance of alternatives the firmer
the lid is on industry pricing.

ACCA P5 Exam Support Notes 33 © Pro Active Resolutions - Mahmood Reza

Substitute products that need to be closely watched are those with improving price-
performance ratios where the industry that produces them is more profitable than yours.

Supplier Power
Profitable suppliers can squeeze profitability out of an industry if that industry cannot
recoup the cost of higher priced supplies in prices of its own products. The conditions
making suppliers powerful are:

It is concentrated with few firms

It does not have to contend with other substitute products for sale to the industry.
The industry is not an important customer.
The suppliers’ product is an important input to the industry.
The supplier group as built up switching costs

Rivalry takes the form of price competition, advertising battles, product introductions,
increased customer service, improvements to warranties and so on. Price competition
can leave the whole industry worse off while advertising battles may increase demand
and hence wealth of firms. Intense rivalry is the result of a number of factors:
Numerous or equally balanced competitors.
Slow industry growth
High fixed or storage costs. The significant cost here is fixed cost relative to
Lack of differentiation or switching costs.
Capacity augmented in large increments
Diverse competitors
High strategic stakes
High barriers to exit. Exit barriers can be economic, strategic and emotional.
They consist of specialised assets, fixed costs of exit, strategic interrelationships,
identification with the business, loyalty to the workforce, fear for one’s own
career, government denial or discouragement of exit and so on.

Threats of Entry
New entrants to an industry bring new capacity, the need to gain market share and they
can bring substantial resources. The threat of entry depends on the strength of the
barriers to entry:
Economies of scale. If these are large then the new entrant has to come in on a
large scale. However these economies of scale must be real. If they are not, as
Xerox discovered when Japanese entrants started following the expiry of patents,
the new entrant may enter at a lower price than the incumbents are
manufacturing for. Scale economies can vary by function, such as selling, or by
operation. For example there are large economies of scale in manufacturing
television colour tubes but not in cabinet making or assembly.
Product differentiation leads to brand identities and customer loyalties.
Capital requirements
Switching costs.
Access to distribution channels which may be difficult if they are controlled by the
Cost disadvantages to the entrant, not brought about by scale, as a result of
proprietary technology, favourable access to materials, favourable locations,
experience curve effects

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Expected retaliations
The entrant will have costs of entry and if the industry price is insufficient to allow
him to recoup these - on other words it is below the ‘Entry Deterring Price’ - he
will not enter. Where however the industry price is significantly above these then
new entrants will tend to bring the price down to it.

Because of the inevitability of the eventual decline of all products and services,
businesses seek to reduce their exposure to the risk of a product decline by maintaining
a portfolio of products.
A balanced portfolio will contain products at various stages of the product life cycle.
Conglomerates will seek to minimise the risks found in individual industries by holding
investments in a range of industries.
There are various tools and techniques for analysing a product or Business Unit
investment, portfolio. The most widely used of these is the Boston Consulting Group
Matrix, often referred to either as the Boston Box or the BCG Matrix. This framework
allows the product portfolio to be identified in terms of market share and market growth.
Products/ services are placed in the matrix and identified as question marks, stars, cash
cows and dogs.


Stars Question


Cash Cows Dogs


High Low
Market Share
(Relative to biggest competitor)


Apart from competitive advantage and entry barriers the company strategy will also
include its decisions on which products to sell in which markets- the so-called
product/market decision. This decision is often illustrated by the Ansoff matrix, called
after Igor Ansoff who originated it in the 1960s. The matrix plots markets against
products giving in each cell the type of strategic decision.

ACCA P5 Exam Support Notes 35 © Pro Active Resolutions - Mahmood Reza

Existing Marke ts New Markets

Existing Products Existing prod uct

Pen etration led strategy

New Products Exisiting

Diversificatio n
A market penetration strategy is one where the company strategy is to increase its
market share in an existing market with current products. This is particularly successful
at developing super-profits when the market is growing strongly. The key strategic
information required is that on the market, its volumes and prices, by customer segment.

A market development strategy is one where the company seeks to increase its
profitability by selling its existing products to new customers (markets) it has never sold
in before. This is most successful when it is based on the most profitable existing
products. The strategic information required here is the direct profit contribution by unit
and an investment strategy based on incremental/opportunity costing based on future

A product development strategy is based on selling new products to existing customers.

Clearly the strategy is most successful when the customers who are approached are
those that are the most profitable to the firm. This will require a soundly based customer
profitability information system.

The diversification strategy requires the company to sell new products to new
customers. Here the management accounting system must be able to clearly identify the
competitive advantage by which the company is going to create its super-profit. Sadly
the evidence is that this is not only the most risky strategy but also one which is
frequently fails.

ROI is similar to the ROCE concept; it is the use and application of the measure that is
different to ROCE. ROI is more commonly applied at the project or SBU (Strategic
Business Unit) level.

Advantages and Disadvantages

The main advantages are that
Calculations are very simple
The entire life of the project is taken into account
Profit is a well understood concept and easily obtainable
As a relative measure ROI enables comparison against projects or SBUs of
varying sizes

ACCA P5 Exam Support Notes 36 © Pro Active Resolutions - Mahmood Reza

The main disadvantages are
The timing of profit flows is completely ignored.
There are a number of different definitions of ROI and various ways of calculating
it which can lead to confusion.
The crucial factor in investment decisions is cash flow and the ROI uses profits.
The technique takes no account of the time value of money.
It takes no account of the incidence of profits;
Averages can be misleading.

This is expressed as an absolute figure, it is normnally calculated as

Profit (EBIT) - Imputed Interest Charge on Project/SBU Investment

The interest charge is a notional charge based normally on a risk adjusted cost of capital
applied to the book value of the value of the investment at the start if each year.

Advantages and disadvantages of residual income

It makes divisional managers aware of the cost of financing their divisions.
It is an absolute measure of performance and not subject to the problems of
relative measures such as return on investment.
In the long run it supports the net present value approach to investment appraisal
(the present value of a project’s residual income equals net present value of that

In common with most other divisional performance measures, problems exist in
defining controllable and traceable income and investment.
Residual income gives the symptoms not the cause of problems. If residual
income falls the figures give little clue as to why.
Problems exist in comparing the performance of different sized divisions (large
divisions will earn larger residual incomes simply due to their size
Residual income when applied on a short term basis is a short term measure of
performance and may lead managers to overlook projects whose payoffs are
long term.


Stern Stewart New York Consultancy Group has ‘trademarked’ the term EVA (Economic
Value Added) for what is an extension/refinement of the Residual Income concept. EVA,
according to the book The Quest for Value – the EVA Management Guide, is simply the
net operating profit after tax less the cost of capital (the weighted average cost of debt
and equity) used in the business.

EVA is seen to the true economic profit made by an enterprise, the concept being that
true shareholder value is created when an organisation generates economic profits in

ACCA P5 Exam Support Notes 37 © Pro Active Resolutions - Mahmood Reza

excess of the financing costs of the economic capital of an organisation. The economic
profits are described as NOPAT (Net Operating Profits after Tax), this being a proxy
measure for net cash flows.

NOPAT is arrived at by making a number of adjustments to accounting profit, example

adjustments being for amortised goodwill, non-cash expenses, provisions and interest

The economic capital is arrived at by making a number of adjustments to the accounting

measure of capital, example adjustments being for amortised development costs and
goodwill, provisions for doubtful debts.

The financing costs represent the target WACC applied to the economic capital


The NPV approach to capital investment appraisal is based on the simple notion that,
after discounting the projected cash flows, both in and out, an investment is likely to be
worthwhile if the present value of the inflows exceeds the present value of the outflows.
This condition is a positive net present value and indicates that the investment as
projected will earn more than the interest rate used to discount the cash flows. In
economic terms, the NPV represents the change in the value of the firm if the project is

If the present value of the outflows exceeds the present value of the inflows, that is the
project yields a negative net present value, then the investment as projected is earning
less than the discount rate and should be rejected.

The discount rate used represents the rate of return required to make the investment
worthwhile, hence the accept/reject approach adopted above where respective positive
and negative net present values are achieved.


The internal rate of return (IRR) is a technique of investment appraisal which is related to
the NPV method. Using the NPV approach it is possible to demonstrate that a project
which is discounted at, say, a discount rate of 10% will be feasible because it gives a
positive net present value. If the discount rates are successively increased, the net
present value will steadily fall, go through zero, and then become negative, illustrating
that higher discount rates cause fewer projects to be worthwhile. The IRR is the
discount rate which applies when the present value of inflows equals the present value
of outflows, that is, the net present value is zero.

Once calculated, the IRR for a project is compared with the target return required by the
organisation. If it is greater than or equal to the latter, the project is likely to be worth-
while. If it is less than the target return, the project should be rejected. Investments in
mutually exclusive projects are ranked according to the size of the IRR.

ACCA P5 Exam Support Notes 38 © Pro Active Resolutions - Mahmood Reza

EPS (earnings per share) is an accounting based measure and is considered, on its own
to be a weak measure of shareholder value. Earnings are based on the accounting
measurement of post-tax profit; measuring increases in shareholder value using profit
based measures are usually weaker than using cash based measures.

Some of the reasons cited for the weaknesses of EPS are

1. Alternative accounting methods may be employed, albeit different ways of reporting

earnings does not affect underlying economic value,
2. Risk is excluded and is not accounted for in annual reports,
3. Investment requirements are excluded (changes in for example the working capital
are not considered in reported earnings),
4. Dividend policy is not considered
5. The time value of money is ignored
6. Intangible assets, such as intellectual property play a greater role in an increasing
service and knowledge oriented economy – this is not directly reflected in the EPS

Intangibles are generally still not regarded as assets in traditional accounting systems,
unless they comply with formal accounting recognition rules.


Global Inc. is currently considering a capital project that will last for three years; the
following data has been collected:

1. The project will require an investment of $66 million, it will have no residual value
and depreciation is calculated on a straight line basis.
2. The project is expected to generate annual revenue flows of $80m in year 1,
$90m in year 2 and $100m in year 3.
Year 1 Year 2 Year 3
Sales volumes 1.8 million 2 million 2½ million
Unit selling price $60 $60 $60
3. Incremental costs $40million $45million $50million
4. The project is forecast to have a contribution to sales ratio of 60% throughout the
three year period.
5. Immediate investment in working capital will be as below; these amounts would
be recovered in full at the end of the three year period.
Inventory $5m
Receivables $5m
Payables $3m

The cost of capital to be used is 12%.

Assumptions and additional information:

All cash flows other than the initial capital and working capital investment occur
at the end of each year.
Use the net book value of the asset at the start of each year to represent the
value of the asset for the year
Ignore taxation.

ACCA P5 Exam Support Notes 39 © Pro Active Resolutions - Mahmood Reza

a. Prepare a table for each year of the project showing
Net profit
Residual income using straight line depreciation
Return on investment using straight line depreciation
Residual income using annuity depreciation
Return on investment annuity depreciation

b. Calculate the projects Net Present Value (NPV) and Internal Rate of Return

ACCA P5 Exam Support Notes 40 © Pro Active Resolutions - Mahmood Reza

It has become increasingly important for organisations to develop systems of
performance measurement which not only reflect the growing complexity of the business
environment but also monitor their strategic response to this complexity. The need for
good performance management is an ongoing issue, some of the main issues requiring
consideration by management are:

Setting performance standards and targets

Linking rewards to performance
Considering the potential benefits and problems of performance measures.

In attempting to establish a clear link between performance and strategy it is vital that
management ensures that the performance measures target areas within the business
where success is a critical factor. The criteria for selecting performance measures for the
scorecard are


The start point is usually an organisation’s underlying mission, vision and strategic
direction, in general the approach

1 Identify key objectives – known as Critical Success Factors (CSFs)

2 Establish measures for CSFs – measures are known as Key Performance
Indicators (KPIs), these are driven by CSFs
3 Set target KPIs
4 Establish initiatives and ways to achieve the above
5 Devise methods of capturing the data and processing the information
6 Monitor the above via management reporting

The above can be seen as a cascading effect, i.e. CSFs determine KPIs, we then set a
target and then consider ways to achieve the target KPI; the KPIs are then calculated,
monitored and reported to the board and operational managers. If the target KPIs are
not being met then appropriate action can be taken.

Some sense of prioritisation has to occur otherwise we will merely end up calculating
and monitoring a list of KPIs that have no cohesive linkage and can cause us to lose
sight of our main strategic purpose. This methodology, if developed and implemented
effectively replaces the conventional budgetary reporting system where the focus is
more on cost control – important but not the sole determinant of achieving our ultimate

ACCA P5 Exam Support Notes 41 © Pro Active Resolutions - Mahmood Reza

Name Clear indicator name
Identification of what strategic element is
Strategic element being assessed being assessed (e.g. a specific resource,
a core competence, one of the output
Purpose Descriptions of the key purpose

Data collection method Short description of how the data is

• Formula and/or scale Identification of the scale used to assess
• Source of data
Identification of where the data comes
• Frequency
How often is the indicator measured?
• Data entry
Who is collecting and updating the date?

Ownership Identification of the person(s) of

function(s) responsible for the measured
Targets and performance thresholds Identification of targets, benchmarks, and
thresholds for traffic lighting

• Audience/access Identifies the audience, outlets, and

access rights
• Reporting frequency Identifies how often the indicator is

• Reporting formats Identified how the performance is

presented (numerical, graphical,
narrative formats)
• Notifications/workflows Identifies proactive notifications and
Expiry/revision date Identifies an expirations or revision date

Cost estimate Estimation of the costs incurred by

introducing and maintaining this indicator

Confidence level Evaluation: e.g. good fair : imperfect

Written comment
Reproduced from Strategic Performance Management, B Marr, 2006

ACCA P5 Exam Support Notes 42 © Pro Active Resolutions - Mahmood Reza

Traditionally, three types of performance measures have been encountered in practice.
Each is discussed in turn.

Input Measures
At the lowest end of the performance measurement spectrum is the tracking of program
inputs. Typical inputs include staff time and budgetary recourses.

Inputs are generally the simplest elements to measure, but provide limited information
for decision – making and analysis of actual results.

Output measures
Results generated from the use of program inputs are the domain of the output measure.
Theses metrics track the number of people served, services provided, or units produced
by a program or service. They may sometimes be referred to as activity measures.
Depending on the nature of the program or services, output measures may provide
information on whether desired results are being achieved.

Outcome measures
Outcomes track the benefit received by stakeholders as a result of the organisation’s
operations. Whereas inputs and outputs tend to focus internally on the program or
service itself, outcomes reflect the concerns of the participants (clients, customers, other
stakeholders). Outcome measures shift the focus from activities to results, from how a
program operates to the good it accomplishes. Outcome measures offer many

Outcomes demonstrates results, and in today’s environment that is exactly what

everyone, from the general public to the world’s most generous philanthropists,
are demanding from public and non-profit organisations.
Outcomes provide guidance in resource allocations. Funding can be directed in
alignment with those actions that produce documented results.
Focus on outcomes, rather than inputs or outputs, serves to guide the entire
organization toward its true aims.

Accountability is enhanced when the focus shifts to outcomes. Administrators

cannot hide behind data indicating numbers served, but must outline specifically
how targeted audiences are better off as a result of their program or service.

There are a number of models of performance measurement which can be used by



The performance pyramid derives from the idea that an organisation operates at
different levels each of which has a different focus. However, it is vital that these
different levels support each other. Thus the pyramid links the business strategy with
day-to-day operations.

In proposing the use of the performance pyramid Lynch and Cross suggest measuring
performance across nine dimensions. These are mapped onto the organisation - from
corporate vision to individual objectives.

ACCA P5 Exam Support Notes 43 © Pro Active Resolutions - Mahmood Reza

Within the pyramid the corporate vision is articulated by those responsible for the
strategic direction of the organisation. The pyramid views a range of objectives for both
external effectiveness and internal efficiency. These objectives can be achieved through
measures at various levels as shown in the pyramid. These measures are seen to
interact with each other both horizontally at each level, and vertically across the levels in
the pyramid.

At the bottom level of the pyramid is what Lynch and Cross refer to as 'measuring in the
trenches'. Here the objective is to enhance quality and delivery performance and reduce
cycle time and waste. At this level a number of non-financial indicators will be used in
order to measure the operations. The four levels of the pyramid are seen to fit into each
other in the achievement of objectives. For example, reductions in cycle time and/or
waste will increase productivity and hence profitability and cash flow

The strength of the performance pyramid model lies in the fact that it ties together the
hierarchical view of business performance measurement with the business process
review. It also makes explicit the difference between measures that are of interest to
external parties - such as customer satisfaction, quality and delivery - and measures that
are of interest within the business such as productivity, cycle time and waste.

Lynch and Cross concluded that it was essential that the performance measurement
systems adopted by an organisation should fulfil the following functions:

1. The measures chosen should link operations to strategic goals. It is vital that
departments are aware of the extent to which they are contributing - separately
and together - in achieving strategic aims.
2. The measures chosen must make use of both financial and non-financial
information in such a manner that is of value to departmental managers. In
addition, the availability of the correct information as and when required is
necessary to support decision-making at all levels within an organisation.
3. The real value of the system lies in its ability to focus all business activities on the
requirements of its customers.

These conclusions helped to shape the performance pyramid which can be regarded as
a modeling tool that assists in the design of new performance measurement systems, or
alternatively the re-engineering of such systems that are already in operation.

ACCA P5 Exam Support Notes 44 © Pro Active Resolutions - Mahmood Reza

The performance pyramid (Lynch and Cross, 1991)

The Balanced Scorecard was developed by Kaplan and Norton as an attempt to counter
a rather narrow-minded approach to performance management that relied too heavily on
financial measures. The Balanced Scorecard approach relies on the organisation
defining key dimensions of performance for which discreet yet linked measures can be
reported. The following categories, or perspectives, are measured:

Internal Process
Learning and growth

The balanced scorecard depicted above is a carefully selected set of quantifiable

measures obtained from an organisation’s strategy. The measures selected represent a
communication tool to employees and external stakeholders the outcomes and
performance drivers by which the organisation will achieve its mission and strategic

A framework is developed within each of the four perspectives that helps describe the
key elements of strategy; the framework is made up of:


ACCA P5 Exam Support Notes 45 © Pro Active Resolutions - Mahmood Reza


Whom do we define as
our customer?
How do we create value
for our customer?

Financial Internal Processes

How do we add value To satisfy customers

for customers while Strategy while meeting budgetary
controlling costs? constraints, at which
business processes
must we excel?

Employee Learning
& Growth

How do we enable
ourselves to grow &
change, meeting
ongoing demands?

Customer Perspective
Two key questions need to be asked here:

Who are our target customers?

What is our value proposition in serving them?

Example measures could include

Specifications (customer driven): Product quality (restaurant) & service quality

Service: Responsiveness & customer satisfaction surveys
Market share: Product/service mix & Innovations and competency

Internal Process Perspective

What are the key processes which we must excel at in order to continue to add value for
customers? Service development and delivery, partnering with the community, and
reporting are examples that could be used.

ACCA P5 Exam Support Notes 46 © Pro Active Resolutions - Mahmood Reza

Learning and Growth Perspective
There will normally be a gap between current organisational infrastructure of employee
skills, information systems, and organisational culture and the level necessary to achieve
the results that are desired.

The measures that are used and designed in this perspective will help close the gap.
Employee skills, employee satisfaction, education training, internal rewards and
recognition are examples of such measures.

Financial Perspective

The measures in this perspective tell us whether our strategy execution and
implementation, detailed through measures in the other perspectives, leads to improved
bottom-line results. Typical examples include shareholder value increase, gearing.

ACCA P5 Exam Support Notes 47 © Pro Active Resolutions - Mahmood Reza

Generic Health care Airlines Banking

% of earned Patient census Revenue/cost Outstanding

Financial income Unit per available loan balances
Strength Income growth profitability passenger Deposit
(Looking Back) Operating funds raised mile balances
surplus for capital Mix of freight Non- interest
Cash balances improvements Mix of full fare income
Reserves Cost per care To discounted
Percent of Average age
revenue – new of fleet
programmes Available seat
miles and
related yields
Customer Patient Lost bag Customer
Customer Satisfaction Satisfaction reports retention
Service & Customer survey per 10 000 Number of
Satisfaction retention Patient passengers new
(Looking from Quality customer retention Denied Customers
the outside in) service Patient referral boarding rate Number of
Income from new rate Flight products per
products/services Admittance of cancellation customer
discharge rate Customer Face time
timeliness complaints spent between
Medical plan filed with the loan officers
awareness DOT and customers
Delivery time Weekly patient Load factors Sales calls to
Internal Cost complaints (percentage of potential
Operating Process quality Patient loads seats customers
Efficiency Error rates on Breakthroughs occupied) Thank You
(Looking from processes in treatments Utilisation calls or cards
the inside out) Supplier and medicines factors on to new and
Satisfaction Infection rates aircraft and existing
Readmission personnel customers
rate On-time Cross selling
Length of stay performance statistics

Employee Skill Training hours Employee Test results

Learning and level per caregiver absenteeism from training
Growth Training Number if peer Worker safety knowledge of
(Looking availability reviewed statistics product
ahead) Employee papers Performance offerings, sales
satisfaction published appraisals and service
Job retention Employee completed Employee
Amount of turnover rate Training satisfaction
unpaid overtime programmes survey
worked hours per

ACCA P5 Exam Support Notes 48 © Pro Active Resolutions - Mahmood Reza

Target costing should be viewed as an integral part of a strategic profit management
system. The initial consideration in target costing is the determination of an estimate of
the selling price for a new product which will enable a firm to capture its required share
of the market. It is then necessary to reduce this figure to reflect the firm's desired level
of profit, having regard to the rate of return required on new capital investment and
working capital requirements. The deduction of required profit from the proposed selling
price will produce a target price that must be met in order to ensure that the desired rate
of return is obtained. The main theme of target costing is, therefore, what a product
should cost in order to achieve the desired level of return.

Target costing will necessitate comparison of current estimated cost levels against the
target level. This must be achieved if the desired levels of profitability, and hence return
on investment, are to be achieved. Where a gap exists between the current estimated
cost levels and the target cost, it is essential that this gap is closed.

Target costing overview:

Understand Customer Need

Price Sensitivity Value of product


What What
Price Features

Set Profit

Set Target Cost

ACCA P5 Exam Support Notes 49 © Pro Active Resolutions - Mahmood Reza

The performance prism was devised by Cranfield University and is one that considers all
organisational stakeholders, without necessarily focusing on one group. The
organisation considers what its stakeholders need and want from the organisation, and
consequently what the organisation needs and wants from its stakeholders.

There are five facets to The Performance Prism, namely

Stakeholder satisfaction
Stakeholder contribution

The Performance Prism is distinct from other models in that:

It is stakeholder driven, and not strategy driven.

The concept of stakeholders is more inclusive, and does not just consider shareholders
and customers
Success is seen as based on ‘successful’ partnerships and inter-relationships between
the organisation and stakeholders
Measures can be generated and used for all levels within an organisation

When designing the prism, the five facets referred to above prompt specific questions
(and answers), namely
Stakeholder satisfaction – Who are the key stakeholders, what do they want and
Strategies – What strategies do we need to put in place to satisfy the wants and
needs of our key stakeholders?
Processes – What critical processes do we need to put in place to enable us to
execute our strategies?
Capabilities – What capabilities do we need to put in place to allow us to operate,
maintain and enhance our processes?
Stakeholder contribution – What contributions do we want and need from our
stakeholders if we are to maintain and develop these capabilities?


TQM is a philosophy of quality management that originated in Japan in the
1950s, it seeks to integrate the quality management efforts of all groups in an
organisation and is considered to be a significant factor in Japanese global business

The basic principle of TQM is that costs of prevention (getting things right first time) are
less than the costs of correction. This is contrasted with the ‘traditional’ approach which
takes the view that that less than 100% quality is acceptable as the costs of reaching
100% outweigh the benefits.

There are four categories of TQM costs

ACCA P5 Exam Support Notes 50 © Pro Active Resolutions - Mahmood Reza

Prevention costs
Costs incurred in preventing the production of products that do not conform to
specification. They include the costs of preventive maintenance, quality planning &
training & the extra costs of acquiring high quality raw materials.

Appraisal costs
Costs incurred to ensure that materials & products meet quality conformance standards.
They include the costs of inspecting purchased parts, work in process & finished goods,
quality audits & field tests.

Internal failure costs

Costs associated with materials & products that feel to meet quality standards. They
include costs incurred before the product is despatched to the customer, such as the
costs of scrap, repair, downtime & work stoppages caused by defects.

External failure costs

Costs incurred when products or services fail to conform to requirements or satisfy
customer needs after they have been delivered. They include the costs of handling
customer complaints, warranty replacement, repairs of returned products & the costs
arising from a damaged company reputation. Costs within this category can have a
dramatic impact on future sales.

Opportunity costs
Advocates of TQM argue that the impact of less than 100% quality in terms of lost
potential for future sales also has to be taken into account.

ACCA P5 Exam Support Notes 51 © Pro Active Resolutions - Mahmood Reza


1. Not-For-Profit Organisations, R Souster, Sept and Oct 2009

2. Transfer Pricing, K Garrett, October 2009
3. The risks of uncertainty, M Pogue, April 2009
4. Accounting And Organisational Cultures, G Morgan, Nov/Dec 2008
5. Business failure, prediction and prevention, M Pogue, June/July 2008
6. Economic Value Added, Creating Value, S Johnson & M Bamber, Oct 2007
7. Critical Success Factors, J Stone, August 2006
8. Defining Managers’ Information Requirements, J Stone, August 2006
9. Business Strategy And Performance Models, S Johnson, April 2006
10. The pyramids & pitfalls of performance measurement, S Johnson, Sept 2005
11. Performance measures to support competitive advantage, G Morgan, Aug 2005
12. Beyond budgeting, S Johnson, Mar 2005
13. Management control - a pre-requisite for survival, S Johnson, Oct 2004
14. Environmental management accounting, S Johnson, Jun 2004
15. Just-in-time operations and Backflush accounting, S Johnson, May 2004
16. Budgetary control - the organisational aspects, M Tayles, Dec 1998

ACCA P5 Exam Support Notes 52 © Pro Active Resolutions - Mahmood Reza

Contingency tables

Purchased 50 100 150 200

Demand kg
60 30 20 0 -20
100 30 60 40 20
125 30 60 65 45
175 30 60 90 95


Minimum 30 20 0 -20

Maximum 30 60 90 95

Maximin 30

Maximax 95

Minimax regret

Purchased kg 50 100 150 200

Demand kg
60 0 10 30 50
100 30 0 20 40
125 35 5 0 20
175 65 35 5 0

Qty purchased 50 100 150 200

Max regret 65 35 30 50

Minimax 30

ACCA P5 Exam Support Notes 53 © Pro Active Resolutions - Mahmood Reza

Provide Inc. and Receive Inc: Transfer Pricing
Provide Inc.: Total output 36,000
Sales to Receive Inc. 9,000
Sales outside group 27,000

a. Monthly profit at existing sales level

Qty Unit data Sales
Containers $ £
Receive Inc. Sales 9,000 30.00 270,000
Costs: Materials 9,000 14.00 (126,000)
Costs: Other 9,000 5.00 ( 45,000)
Contribution 99,000
Fixed costs ( 60,000)
Profit 39,000

Qty Unit data Sales

Containers $ £
Provide Inc. Sales 36,000 14.00 504,000
Costs: Materials 36,000 7.00 (252,000)
Contribution 252,000
Fixed costs ( 80,000)
Profit 172,000

Revised sales levels Existing Change Revised

Containers % Containers
Total output of Provide Inc. 36,000 42,750
Receive Inc. 9,000 75.0% 15,750
Sales outside group 27,000 0.0% 27,000

b. Monthly profit at revised sales level

Qty Unit data Sales
Containers $ $
Receive Inc. Sales 15,750 24.00 378,000
Costs: Materials 15,750 14.00 (220,500)
Costs: Other 15,750 5.00 ( 78,750)
Contribution 78,750
Fixed costs ( 60,000)
Profit 18,750
Initial profit b/f 39,000
Profit movement ( 20,250)

Qty Unit data Sales

Drums $ £
Provide Inc. Sales 42,750 14.00 598,500
Costs: Materials 42,750 7.00 (299,250)
Contribution 299,250
Fixed costs ( 80,000)
Profit 219,250

ACCA P5 Exam Support Notes 54 © Pro Active Resolutions - Mahmood Reza

Initial profit b/f 172,000
Profit movement 47,250

Total (consolidated) Revised total profit 238,000

Initial total profit b/f 211,000
Total profit movement 27,000

c. Spare capacity of Provide Inc. (52,000 – 36,000) 16,000
Additional output of Provide Inc. 6,750

Receive Inc: loss of profits -$20,250

Receive Inc.: loss of profits/container -$3

Per container
Provide Inc.: existing variable cost $7

Set transfer price above $7 per drum and below $14

ACCA P5 Exam Support Notes 55 © Pro Active Resolutions - Mahmood Reza

Global Inc.: Project assessment performance measures

Year 0 Year 1 Year 2 Year 3
$m $m $m $m
Net book value (NBV) 66.0 66.0 44.0 22.0

Sales volume: million 1.8 2.0 2.5

Unit selling price $60.00 $60.00 $60.00
Sales: million $108.0 $120.0 $150.0
Contribution $64.8 $72.0 $90.0
Incremental costs -$40.0 -$45.0 -$50.0

EBITDA: million
(Contribution less incremental costs) $24.8 $27.0 $40.0

Working Capital (WC)

Inventory -$5.0 $5.0
Receivables -$5.0 $5.0
Payables $3.0 -$3.0

Net operational cash flows (NCF)

(EBITDA less WC investment $17.8 $27.0 $47.0

Less: depreciation
Profit -$22.0 -$22.0 -$22.0
(NCF minus depreciation) -$4.2 $5.0 $25.0

Imputed interest at 12% on NBV

(NBV b/f ! cost of capital) -$7.9 -$5.3 -$2.6

Residual income: straight line

(Profit minus interest) -$12.1 -$0.3 $22.4

Return on investment: straight line

(Profit " NBV b/f) -6.4% 11.4% 113.6%

Annuity depreciation approach

Initial investment: million $66.0

Annuity factor 12% 2.402
Equivalent annual cost $27.5

Year 1 Year 2 Year 3

$m $m $m
Net book value (NBV) b/f 66.0 44.0 22.0
Imputed interest at 12% on NBV
(NBV b/f ! cost of capital) -7.9 -5.3 -2.6
Annuity depreciation

ACCA P5 Exam Support Notes 56 © Pro Active Resolutions - Mahmood Reza

(EAC minus interest) 19.6 22.2 24.8

Year 1 Year 2 Year 3

$m $m $m
Net operational cash flows (NCF) 17.8 27.0 47.0
Annuity depreciation -19.6 -22.2 -24.8
(NCF minus depreciation) -1.8 4.8 22.2

Imputed interest at 12% on NBV

(NBV b/f ! cost of capital) -7.9 -5.3 -2.6

Residual income: annuity depreciation

(Profit minus interest) -9.7 -0.5 19.5

Return on investment: annuity depreciation

(Profit " NBV b/f) -2.7% 7.3% 33.6%

NPV Year 0 Year 1 Year 2 Year 3

$m $m $m $m
Investment -$66.0

Net operational cash flows $17.8 $27.0 $47.0

Total net cash flows -$66.0 $17.8 $27.0 $47.0

Discount factor: 12% 1.000 0.893 0.797 0.712

Present value -$66.0 $15.9 $21.5 $33.5

NPV $4.9

Calculate IRR Discount Discount

Cash flow factor PV factor PV
$m 12.0% $m 20.0% $m
Year 0 -66.0 1.000 -66.0 1.000 -66.0
Year 1 17.8 0.893 15.9 0.833 14.8
Year 2 27.0 0.797 21.5 0.694 18.8
Year 3 47.0 0.712 33.5 0.579 27.2

4.9 -5.2

IRR 12% + (4.9 ) × (20-12)% 15.9%


ACCA P5 Exam Support Notes 57 © Pro Active Resolutions - Mahmood Reza