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Performance Management
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Answering the question set
ACCA
Paper F5
Performance Management

Final Mock Examination

Question Paper

Time allowed

Reading and planning: 15 minutes

Writing:
3 hours

Instructions:
Please attempt this exam under test conditions and attach the frontsheet complete with your name and address
to your script. The completed package should be sent to BPP Marking Department.
Take a few moments to review the notes on the inside of this page titled, 'Get into good exam habits now!' before
attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS
Get into good exam habits now!
Take a moment to focus on the right approach for this exam.

Effective time management

• Watch the clock, allow 1.8 minutes per mark. Work out how long you can spend on each question
and do not exceed that time.
• Take a few moments to think what the requirements are asking for and how you are going to
answer them.

Effective planning
• This paper is in exactly the same format as the real exam. You should read through the paper and
plan the order in which you will tackle the questions. Always start with the one you feel most
confident about and take time to choose the questions you will answer in sections with choice.
• Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
• Identify and make sure you pick up the easy marks available in each question.

Effective layout
• Present your numerical solutions using the standard layouts you have seen. Show and reference
your workings clearly.
• With written elements try and make a number of distinct points using headings and short
paragraphs. You should aim to make a separate point for each mark.
• Ensure that you explain the points you are making ie. why is the point a strength, criticism or
opportunity?
• Give yourself plenty of space to add extra lines as necessary, it will also make it easier for the
examiner to mark.

Common terminology
Identify List relevant points
Discuss Explain the opposing arguments
Describe Present the characteristics of
Summarise State briefly the essential points
Recommend Present information to enable the recipient to take action
Analyse Determine and explain the constituent parts of
Explain Set out in detail the meaning of
Illustrate Use an example to explain something
Appraise/assess/
evaluate Judge the importance or value of

2
ALL FOUR questions are compulsory

1 Chocoholics Anonymous
Chocoholics anonymous are looking to launch 2 new products.
The first is called Paradise and will require hire of additional equipment. The machines have varying
capacities but they need to be ordered now before demand is known.
The management accountant has prepared a table detailing the various possible profits that could arise
depending on level of demand, contribution and the varying cost of equipment hired.
Equipment Capacity (boxes)
Demand p 2,000 3,000 5,000
(boxes)

1,500 0.2 17,500 15,500 12,500

2,500 0.5 25,000 30,500 27,500
5,000 0.3 25,000 38,000 35,000

Those making the decision about the size of equipment that should be hired have conflicting views.
One manager believes the equipment with a capacity of 2,000 boxes should be hired whereas the other
thinks capacity of 3,000 boxes should be obtained.
(a) Explain both managers’ attitude to risk. (4 marks)
The other new product Dreamy contains a special ingredient which isn’t used by the groups other
products.
Due to fierce competition and an influx of new bars in the market recently the management of CA are a
little uncertain as to the likely initial volumes.
The new special ingredient can only be ordered in advance in quantities to fulfil demand of 1,000 boxes,
2,000 or 5,000 boxes of Dreamy so it is important to try and predict demand as accurately as possible.
Based on launches of other new products in the past, initial demand is expected to be as follows:
Quantity demanded Probability
1,000 boxes 20%
2,000 boxes 50%
5,000 boxes 30%
The Dreamy will be sold onto retailers in boxes of 100. Each box will sell for $35. Variable costs
including the cost of special ingredient X are $12
(b) Prepare a table to show the profit values that could occur (9 marks)
(c) Advise the management as to which level of order to place in order to maximise profit (4 marks)
(d) Explain the use and limitations of expected values and what type of person would use them
(8 marks)
(Total: 25 marks)

3
2 Frozen Foods
An extract from an operating statement prepared in a frozen food manufacturing facility shows the
following variances for quarter 1:
$
Materials prices variances
Material A 1,568 F
Material B 815 A
Materials mix variance
Material A 1,399 F
Material B 641 A
Materials yield variance 2,320 A
Materials usage variance 1,562 A
Required:
(a) (i) Explain the meaning of each of the variances. (4 marks)
(ii) Evaluate the performance of the purchasing and production managers (6 marks)
Available data for quarter 2 is as follows:

Standard costs
Material A (2kg @ 3.50) 7.00
Material B (1.5kg @ 5.60) 8.40
Labour (2 hours @ 7.00) 14.00
29.40
Selling price 55.00
Fixed overhead (per qtr) 175,000
Budgeted demand 30,000

Actual data
Actual production and sales were 27,000
Sales revenue achieved was 1,574,000
65,000 kg of material A was purchased costing 213,750
42,000 kg of material B was purchased costing 237,300
Actual hours paid were 54,000 costing 391,500. (Actual hours worked were 52,500)
Actual fixed overheads were 180,000
Required:
(b) Reconcile the budgeted contribution to actual profit for quarter 2 in as much detail as the
information allows. (15 marks)
(Total: 25 marks)

4
3 Olympian plc
Olympian has two divisions. Adlington Division makes units of Ainslie. These can be sold externally and
are also sold onto the Romero Division which processes them further before selling the finished result
onto external customers.
Adlington Romero
External Sales 630,000 705,000
Internal Sales 468,750 -
Total Sales 1,098,750 705,000
Less:
Materials 252,000 60,000
Labour 432,000 120,000
Variable overhead 54,000 15,000
Internal transfer costs 468,750
Fixed overhead 162,000 37,500
900,000 701,250

Net profit 198,750 3,750

Net profit % 18.1% 0.5%

Net assets 850,000 480,000

Olympian‘s MD has seen the last set of financial results and has raised concern that Romero Division is
performing very poorly and is clearly just “not up to scratch” as it is only just covering its costs and is way
off the company target of 15% ROI. He has suggested that the further processing undertaken by this
division is not worthwhile and alternative production opportunities should be considered.
Adlington has a capacity of 100,000 units. Currently it is meeting external demand of 42,000 Ainslies and
supplying 30,000 units of Ainslie to Romero.
Variable costs in Adlington are $10.25 per unit of Ainslie and total production cost is $12.50 per unit
External selling price of the Ainslie is $15
Transfers are made to Romero at full cost + 25% mark up
Required
(a) Comment on the performance of the two divisions, in light of the MDs view that Romero division’s
performance is “not up to scratch”. (5 marks)
(b) It has been suggested that the transfer price should be set at variable cost plus 30%.
(i) Comment on the acceptability of this to both Adlington and Romero (3 marks)
(ii) Reassess the 2 divisions’ performance on this basis and comment on any resulting
changes. (5 marks)
(c) (i) Explain the opportunity cost approach to transfer pricing
(ii) Discuss the use of standard as opposed to actual costs in transfer pricing. (7 marks)
(d) Discuss ROI as a performance measure (5 marks)
(Total: 25 marks)

5
4 Villa Homes
Villa homes designs, manufactures and assembles furniture. The furniture is for domestic homes and
therefore varies considerably in size, complexity and value. One of the departments in the company is the
assembly department. This department is labour intensive; the workers travel to various locations to
assemble and fit the furniture using the packs of finished timbers that have been sent to them.
Budgets are set centrally and they are then given to the managers of the various departments who then
have the responsibility of achieving their respective targets. Actual costs are compared against the
budgets and the managers are then asked to comment on the budgetary control statement. The
statement for April for the assembly Department is shown below.
Budget Actual Variance
Assembly labour hours 6,400 7,140
$ $ $
Assembly labour 51,970 58,227 6,257 Adverse
Furniture packs 224,000 205,000 19,000 Favourable
Other materials 23,040 24,100 1,060 Adverse
Overheads 62,060 112,340 50,280 Adverse
Total 361,070 399,667 38,597 Adverse
The manager of the assembly department is new to the job and has very little previous experience of
working with budgets but he does have many years’ experience as a supervisor in assembly
departments. Based on that experience he was sure that the department had performed well. He has
asked for your help in replying to a memo he has just received asking him to 'explain the serious
overspending in his department'. He has sent you some additional information about the budget:
(1) The budgeted and actual assembly labour costs include the fixed salary of $2,050 for the
manager of the assembly department. All of the other labour is paid for the hours they work.
(2) The cost of furniture packs and other materials is assumed to vary in proportion to the number of
assembly labour hours worked.
(3) Working papers for the budget showed the impact on the overhead costs of differing amounts of
assembly labour hours:
Assembly labour hours 5,000 7,500
Overhead costs $54,500 $76,500
The actual fixed costs for April were as budgeted.
Required
(a) Prepare, using the additional information that the manager of the assembly department has given
you, a budgetary control statement that would be more helpful to him and comment on the
performance of the department . (9 marks)
(b) Discuss the assumption made by the budgeting team of Villa Homes that costs vary in proportion
to assembly labour hours. (3 marks)
(c) Discuss whether Villa Homes should change to a system of participative budgeting. (8 marks)
(d) Discuss the consequences of budgetary slack for cost control. (5 marks)
(Total: 25 marks)

6
Student self-assessment
Having completed this paper take a few minutes to consider what you did well and what you found difficult. Use
this as a basis to focus your future study on effectively improving your performance.
Common problems
Timing and planning
Did you finish too early?
Did you overrun?
Did you waffle?
Layout
Was your answer difficult to follow?
Did you fail to explain each point?
Were some of your workings unclear? Y/N
Content
Did you struggle with:
Interpreting the questions?
Understanding the subject?
Remembering the notes/text?
Future emphasis if you answer Yes
Y/N Focus your planning time on generating more ideas.
Use models to help develop width to your thinking.
Y/N Focus on allocating your time better.
Practise questions under strict timed conditions.
If you get behind leave space and move on.
Y/N Focus your planning time on developing a logical structure to
your answer.
Y/N Use headings and subheadings.
Use numbering sequences when identifying points.
Leave space between each point.
Y/N Show why the point identified answers the question set.
Give yourself time and space to make the marker's job easy.
Y/N Learn the meaning of question words (inside front cover).
Learn subject jargon (study text glossary).
Read questions carefully noting all the parts.
Practise as many questions as possible.
Y/N Review your notes/text.
Work through easier examples first.
Contact a tutor for help.
Y/N Quiz yourself constantly as you study. You need to develop your
memory as well as your understanding of a subject.
7
8
ACCA
Paper F5
Performance Management

Final Mock Examination

Commentary, Marking scheme and

Suggested solutions

ACF5FM08(D)
Commentary
Tutor guidance on improving performance on the exam paper.

General
Your script is the only evidence you will provide to convince an ACCA marker that you should pass this paper
and therefore progress through your qualification. Even very talented students can fall down at this paper
because they do not consider the following points:
The first question should be the question you feel most comfortable with. Give the marker the impression that
you are comfortable with the syllabus as early as possible. Make it clear which question it is you are answering
too!
Make sure you answer ALL questions even if you have to guess. It is amazing how a stab in the dark can
generate the 50th mark – the one you need to pass – again it shows the marker that you can think about the
question (albeit in simple terms).

Q1 Chocoholics Anonymous
Target mark – 17/25
This question covers many of the basics of the risk & uncertainty area of the syllabus. Parts (a) & (d) could have
been answered in isolation . Part (c) involved calculation of expected values and as long as you correctly used
the answers you calculated in (b) you would have scored full marks for this element. Remember to show your
workings for part (b) and in this way you can pick up marks even if your answer is wrong.

Q2 Frozen Foods
Target mark – 17/25
If numbers are your strongest point you may have been best to start with (b). However, you would have needed
to be careful not to overrun on time here.
Part (a) is a very typical interpretation element. Your examiner often examines the interaction and conflict
between variances.

Q3 Olympian plc
Target mark – 17/25
Part (a) tests the much examined area of conflict with performance measurement. You should be prepared for
this type of requirement. Part (b) involves the calculation of division’s profit and ROI if a different transfer price is
used. Marks will be awarded for your conclusions if they are consistent with the numbers you calculated. Parts
(c) & (d) require no application of knowledge, these are purely knowledge areas of the syllabus.

Q4 Villa Homes
Target mark – 17/25
It may have been quickest and easiest to actually start with the written elements in this question. Parts (c) & (d)
whilst requiring an element of application of knowledge should be answered relatively easily using your
knowledge from this area of the syllabus. Leaving part (a) until last should prevent you over running on time.
Remember to always do the easiest calculations first. Here you should attempt the semi variable calculations
last.

2
1 Chocoholics Anonymous
Marking scheme
Marks
(a) 1st manager
– risk averse ½
– maximin ½
– explanation 1
2nd manager
– risk averse ½
– maximin ½
– explanation 1
4
(b) Calculation of each profit value (1 mark each) 9
(c) Each expected value (1 mark each) 3
Selection of highest EV 1 4

(d) Risk neutral 1

Explain uses (1 mark per point) ie dealing with risk, calculate Max 3
average, take highest
Limitations (1 mark per point) ie long run average, ignores risk, Max 4
dependant on probabilities, only used in repeated decisions
8
25

Suggested solution
(a) The first manger is risk averse. He wishes to sign up to a capacity of 2,000 as this has the
highest minimum return (17,500) of the three options. He will not wish to sign up to a level more
than this as the lowest possible returns are below 17,500. This is known as a maximin decision.
The second manager is a risk seeker. He wants the best possible return regardless of the risk
involved. The highest possible return is at 3,000 boxes where there is the chance of a $38,000
return. This is known as a maximax decision.
(b)
Order quantity
Demand p 1,000 2,000 5,000
(boxes)
1,000 0.2 23,000 (W1) 11,000 (W2) (25,000) (W4)
2,000 0.5 23,000 (W1) 46,000 (W3) 10,000 (W5)
5,000 0.3 23,000 (W1) 46,000 (W3) 115,000 (W6)

(W1) Contribution = $23 / unit x 1,000 units sold = $23,000

(W2) Contribution of $23 x 1,000 units – costs of 1,000 extra items bought not sold
(23,000 – (1,000 x $12))
(W3) $23 x 2,000
(W4) $23 x 1,000 – 4,000 x $12
(W5) $23 x 2,000 – 3,000 x$12
(W6) $23 x 5,000

3
(c)
Order quantity
Demand p 1,000 2,000 5,000
(boxes)
1,000 0.2 4,600 2,200 (5,000)
2,000 0.5 11,500 23,000 5,000
5,000 0.3 6,900 13,800 34,500
EV 23,000 39,000 34,500
An order quantity of 2,000 should be placed in order to maximise profit.
(d) The person most likely to use expected values would be a risk neutral person.
Where there is risk, ie the outcome is unknown but past experience exists, a range of possible
future outcomes can be quantified ( for example, best, worst and most likely) and probabilities
assigned to them. A weighted average (or expected value) of these outcomes is calculated.
If a decision maker is faced with a number of alternative decisions, the one with the highest
expected value would be chosen.
The limitations of expected values are that it ignores the risk associated with each possibility. It
is essentially just a long run average, the expected value may not even be a possibility that
exists.
Expected values are heavily dependent on probability estimates.
Expected values are also inappropriate for one–off decisions. They are used when there is
some past experience of an area and as such are then able to apply probabilities to the various
outcomes.

4
2 Frozen Foods
Marking scheme

Marks
(a) (i) Meaning of variances – price 1
– mix 1½
– yield 1½ 4

(ii) Purchasing Manager (1 mark per valid comment) possible

points include initial comment re performance, reasons, 2
overall summary of performance
Production Manager (1 mark per valid comment) possible
points include initial comment re performance based on
4
usage, conclusion & reasons re mix & yield, overall
summary of performance
6

(b) Budgeted contribution 1

Variances – sales price 1
– sales volume 1
– materials price – A 1
– materials price – B 1
– mix 2
– yield 2
– labour rate 1
– labour efficiency 1
– idle time 1
– fixed overhead expenditure 1
Actual profit reconciliation 1
Presentation 1
15
25

Suggested solution
(a) (i) The material price variance is the difference between what the materials purchased should
have cost and what they actually did cost.
Here material A has a favourable material price variance and so the purchasing manager
has actually procured the material more cheaply than expected and material B has an
adverse price variance which means he has spent more than expected.
The mix variance quantifies the impact on profit of using two or more materials in different
proportions to those specified in the standard cost card.
In this case it appears that more of material A (the cheaper of the two materials) was used
in production and less of the more expensive material B.
The yield variance quantifies the impact on profit of too much material being used to
achieve actual production and shows the efficiency of the production process.
The materials yield variance is adverse in this scenario so more material was used than
expected to generate actual production.

5
 (ii) The purchasing manager is responsible for the price variance. On the face of it, it would
appear that he has done a good job as the overall price variance is favourable. It suggests
that he has achieved a good price or discounts from suppliers. However the usage
variance is adverse and this could be caused by the quality of the material purchased. If
the material was of a lower quality than normal (which could be the case with material A)
then this could have been the cause of the adverse yield variance.
The production manager is in control of the usage variances – in other words both the mix
and yield variances. As these are adverse overall it can be said that he has performed
poorly.
The mix variance shows that more of material A has been used than B – this may be due
to the fact that the material was cheaper and so the production manager chose to use
more of this item. However whilst this has driven a favourable mix variance this is
outweighed by the adverse yield variance.
This yield variance is likely to be a consequence of the change of mix in material. It
suggests that the use of material A has caused the process to be less efficient and more
input has been required to achieve the production.
This could be the fault of the production manager as he has altered the mix however, this
could be to compensate for the increase in price of material B. If material A is of a lower
quality then the decision to purchase at this quality could be said to have a detrimental
effect on the whole production and so the purchasing manager has not purchased as
wisely as he thought.
(b) Reconciliation of budgeted and actual profit for quarter 2
Budgeted to actual profit reconciliation:
$
Budgeted contribution (30,000 x $25.60) 768,000
Sales volume variance (W2) 76,800 (A)
691,200
Sales price variance (W1) 89,000 (F)
780,200
Operational cost variances
F$ A$
Materials price A (W3) 13,750
B (W4) 2,100
Materials Mix (W5) 8,100
Yield (W6) 55,000
Labour Rate (W7) 13,500
Efficiency (W8) 10,500
Idle time (W9) 10,500
32,350 81,100 (48,750)
Actual contribution 731,450
Budgeted fixed costs 175,000
Fixed cost expenditure variance (W10) 5,000 (A)
Actual fixed costs 180,000
Actual profit 551,450

6
Check– Actual profit reconciliation
Sales 1,574,000
Less cost of sales:
Material A 213,750
Material B 237,300
Labour 391,500
842,550
Actual contribution 731,450
Less: fixed costs (180,000)
Actual profit 551,450
Workings
(W1) Sales price variance
27,000 units should have sold for (@ $55) 1,485,000
but did sell for 1,574,000
89,000 (F)
(W2) Sales volume variance
Budgeted sales 30,000 units
Actual sales 27,000 units
3,000 units (A)
@ standard contribution per unit x $25.60
$76,800 (A)
(W3) Material A price variance
65,000 kgs should have cost (x $3.5) 227,500
but did cost 213,750
13,750 (F)
(W4) Material B price variance
42,000 kgs should have cost (x $5.6) 235,200
but did cost 237,300
2,100 (A)
(W5) Mix variance
Actual quantity Actual quantity Variance Std cost per kg Variance
@ std mix @ actual mix (kgs) $ $
A 61,143 65,000 3,857 (A) 3.5 13,499.5 (A)
B 45,857 42,000 3,857 (F) 5.6 21,599.2(F)
107,000 107,000 Nil 8,099.7 (F)
(W6) Yield variance
Std quantity @ Actual quantity Variance Std cost per kg Variance
std mix @ std mix (kgs) $ $
A 54,000 61,143 7,143 (A) 3.5 25,000.5 (A)
B 40,500 45,857 5,357 (A) 5.6 29,999.2 (A)
94,500 107,000 12,500 (A) 54,999.7 (A)
(W7) Labour rate variance
$
54,000 hours should have cost (x $7) 378,000
but did cost 391,500
13,500 (A)

7
(W8) Labour efficiency variance
27,000 units should have taken (x 2 hours) 54,000 hours
but did take 52,500 hours
1,500 hours (F)
x std cost per hour x $7
10,500 (F)
(W9) Idle time variance
Actual hours worked 52,500
Actual hours paid 54,000
(1,500)
x std cost per hour x $7
10,500 (A)
(W10) Fixed cost expenditure variance
$
Budgeted fixed cost 175,000
Actual fixed cost 180,000
5,000 (A)

8
3 Olympian plc
Marking scheme
Marks
(a) 1 mark for ROI calc (1/2 each division) 1
1 mark per valid point – to include items such as:
Adlington – looks healthy but guaranteed internal sales & these at
higher than external market price
Romero doesn’t meet target rate but Adlington’s costs not within its
control, could get better price elsewhere therefore not fair
performance measure
Transfer price will impact performance Max 4
5
(b) (i) calculation of transfer price 1
Acceptability to Adlington 1
Acceptability to Romero 1
3
(ii) Internal sales value 1
Net profit calculations (1/2 each division) 1
ROI calculations ( ½ each division) 1
Comment ( 1 each division) 2
5
(c) (i) Explanation of method, acceptable to both parties etc (1 2
mark per valid point)
Results in goal congruence 1
3
(ii) Problems with actual (1 point per mark) Max 2
Reasons for standard being better method (1 point per Max 2
mark)
4
(d) Benefits of ROI (1 point per mark) Max 3
Problems with ROI (1 point per mark) Max 3
Max 5
25

Suggested solution
(a) ROI = net profit / net assets. Adlington = 23.4%. Romero = 0.8%
The targets set for the divisions are to achieve a ROI of 15%, here we can see that Adlington is
achieving this but Romero is significantly off this target and hence the MD’s comments.
However, Romero contains costs which it cannot control.
The units transferred to Romero are done so at full cost plus 25% ($15.625). Not only does
Romero have no control over this cost but it is also greater than the amount Romero could
obtain the units for if they were to purchase them from the external market ($15).
Adlington is always going to look as though it is performing well as it is guaranteed to sell 30,000
units at a profit of 25%. Romero is therefore contributing to the profitable performance of
Adlington, whilst being penalised itself as it could actually buy the units cheaper elsewhere.
The use of the transfer price chosen will have a significant impact on the resulting profitability of
the two divisions and therefore on their respective ROIs.
Unless an appropriate transfer price is chosen, ROI is unlikely to be an equitable measure.

9
(b) (i) Variable cost plus 30% equates to a transfer price of $13.325.
As Adlington have spare capacity and have fulfilled external demand any transfer price
that covers their variable costs (and ideally contributes towards fixed costs) is
acceptable. As such they should be happy with this transfer price even though it is lower
than the current one.
Romero will be prepared to pay up to external market price. As this is below the
external market price, Romero will also be happy with this transfer price.
(ii)
Adlington Romero
External Sales 630,000 705,000
Internal Sales (30,000 @ 13.325) 399,750 -
Total Sales 1,029,750 705,000
Less:
Materials 252,000 60,000
Labour 432,000 120,000
Variable overhead 54,000 15,000
Internal transfer costs 399,750
Fixed overhead 162,000 37,500
900,000 632,250

Net profit 129,750 72,750

Net profit % 12.6% 10.3%

Net assets 850,000 480,000

ROI % 15.3% 15.2%

Adlington’s profit and ROI is obviously lower with the new transfer price however, at an
ROI of 15.3% it still meets the company’s target rate.
Romero has seen a significant turn around in its performance. From just about breaking
even it is now contributing a reasonable profit and is also now achieving the company
target rate of a 15% ROI.
(c) (i) With an opportunity cost approach, the transfer price is set at the standard variable cost
per unit in the supplying division plus the opportunity cost to the organisation as a
whole of supplying the unit internally instead of externally (ie the lost contribution from
transferring internally)
If there is no external market for the service being transferred and no alternative uses for
the supplying division's facilities, the method will give a transfer price of variable
(marginal) cost, with its accompanying consequences.
A transfer price using opportunity costs should always encourage both divisions to
make the transfer and ensure goal congruence is maintained.

10
 (ii) When a transfer price is based on cost, standard cost should be used, not actual cost.
A transfer at actual cost would give the supplying division no incentive to control costs
because all of the costs could be passed on to the receiving division. Actual cost plus
transfer prices might even encourage the manager of the supplying division to overspend,
because this would increase divisional profit, even though the organisation as a whole
(and the receiving division) suffers.
Standard cost based transfer prices should encourage the supplying division to become
more efficient as any variances that arise would affect the results of the supplying division
(as opposed to being passed on to the receiving division if actual costs were used).
The receiving division would much prefer use of standard costs as the division then knows
upfront how much will be paid for the goods and any variances used to measure the
division’s performance are variances within its control.
(d) ROI is a useful performance measure when comparing different divisions or investments as the %
result means that differing size divisions / investments can be compared.
The result is easily calculated as it only requires information that is already present in the
financial statements.
It also is a measure that is consistent with ROCE%.
However it does have limitations. The ratio will be distorted by the age of the assets. The older
the assets the lower their book value and so a division with older assets can look as though it is
performing better than a decision with new assets. This can lead to further issues as if applied
purely it can result in dysfunctional behaviour as only projects which increase ROI will be
accepted, even if they meet the desired target return for the group.
ROI is based on profit and profit can be manipulated. If a manager is bonused upon meeting
this target he may therefore take decisions which are in his own interest rather than the interest
of the company

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4 Villa Homes
Marking scheme
Marks
(a) Flexed budget
Each variable cost (1 each) 4
Fixed cost (1/2 each) 1
Cost variance (1/2 each) 3
Format 1
9
(b) 1 mark per valid point eg (complex nature, not appropriate as 3
evidenced by variances, ABB better approach)

(c) Discussion of budget participation ie top down, bottom up or 6

negotiated, 1 mark per point, to a max of
Conclusion including justification (1 mark each) 2
8
(d) Explanation of budgetary slack 1
Explanation of cost control 1
Consequences – one mark for each valid point, to a max of 3
5
25

Suggested solution
(a)
Original Flexed Actual
budget budget costs Variance

Assembly labour hours 6,400 7,140 7,140

$ $ $ $
Variable costs
Assembly labour (W1, W2) 49,920 55,692 56,177 485 (A)
Furniture packs (W3) 224,000 249,900 205,000 44,900 (F)
Other materials (W4) 23,040 25,704 24,100 1,604 (F)
Variable overheads (W5) 56,320 62,832 76,340 13,508 (A)
Variable costs 353,280 394,128 361,617 32,511 (F)
Fixed costs
Manager 2,050 2,050 2,050 –
Fixed overheads 10,500 10,500 10,500 –
Total departmental fixed costs 12,550 12,550 12,550 –

Total costs 365,830 406,678 374,167 32,511 (F)

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 Workings
1 Both budgeted and actual assembly labour costs given include manager's fixed salary of
$2,050 which has to be deducted
$51,970 – $2,050 = $49,920
Budgeted assembly labour costs per hour are:
49,920
= 7.80 per hour
6,400
Flexed budget @ 7,140 hours = 55,692

2 The actual variable labour cost is:

$58,227 – $2,050 = $56,177

3 Budgeted variable cost of furniture packs:

224,000
= 35.00 per hour
6,400
Flexed budget @ 7,140 hours = 249,900

4 Budgeted variable cost of other materials:

23,040
= 3.60 per hour
6,400
Flexed budget @ 7,140 hours = 25,704

5 The budgeted overheads are a semi-variable cost.

Hours Cost
7,500 76,500
5,000 54,500
2,500 22,000
... VC/unit = 22,000 / 2,500 = $8.80
By substitution into high output:
Total VC (7,500 @ 8.80) = $66,000
∴ Total FC = $76,500 – $66,000
= $10,500
Flexed budget @ 6,400 hours Variable cost = 56,320
Actual at 7,140 hours Variable cost = 62,832
(b) The cost of furniture packs and other materials is assumed to vary in proportion to the number of
assembly hours worked. As a result the variable costs have been flexed in relation to the number
of assembly hours worked.
This, however, may not result in the most appropriate allocation of costs as we are told that the
furniture 'varies considerably in size, complexity and value'. It would therefore follow that the
assembly would also vary significantly between products.
The fact that the variable cost allocation may not reflect the true cost of assembly it may be
evidenced by the fact that there is a substantial favourable variance in the cost of furniture
assembled but a significant adverse one in terms of variable costs.
The company may consider using activity based budgeting as a more effective way of
determining what causes the variations in costs.

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(c) Participation in the budget-setting process
There are essentially two ways in which a budget can be set: from the top down or from the
bottom up.
In the top-down approach to budgeting, top management prepare a budget with little or no input
from operating personnel which is then imposed upon the employees who have to work to the
budgeted figures.
The advantages of this approach are that strategic plans are likely to be incorporated into
planned activities; coordination between the plans and objectives of divisions is enhanced;
senior management's awareness of total resource availability is used; the period of time taken to
draw up the budgets is decreased.
The disadvantages of top-down budgeting are dissatisfaction, defensiveness and low morale
amongst employees; the acceptance of organisational goals and objectives could be limited; the
feeling of the budget as a punitive device could arise; lower-level management initiative may be
stifled.
In the bottom-up approach to budgeting, budgets are developed by lower-level managers who
then submit the budgets to their superiors. The budgets are based on the lower-level managers'
perceptions of what is achievable and the associated necessary resources.
The advantages of participative budgets are they are based on information from employees most
familiar with the department; morale and motivation is improved, resulting in improved
quality of the decisions made; they increase operational managers' commitment to
organisational objectives; co-ordination between units is improved; specific resource requirements
are included.
There are, on the other hand, a number of disadvantages which Villa Homes should consider
before introducing participative budgets. They consume more time, meaning an earlier start to
the budgeting process could be required; changes implemented by senior management may
cause dissatisfaction; they may cause managers to introduce budgetary slack; setting easy
targets which they know are achievable.
The allocation of overheads in Villa Homes is likely to vary considerably depending on the size,
complexity and value of the furniture being assembled. It is, therefore, important to involve
employees with detailed knowledge of the process. This will not only draw on useful experience
but also increase motivation and commitment. A participative budgeting approach would
therefore be worthwhile adopting as long as Villa Homes are mindful of the disadvantages and are
careful to ensure budgetary slack is avoided.
Negotiated style of budgeting
Many organisations in practice develop a budget setting process that incorporates elements of
both approaches, where budgets are agreed by a process of negotiation. A negotiated budget
is a 'budget in which budget allowances are set largely on the basis of negotiations between
budget holders and those to whom they report.'
(d) Budgetary slack occurs when managers aim to give themselves easier budget targets by
understating budgeted sales revenue or overstating budgeted costs.
Cost control using budgets is achieved by comparing actual costs for a budget period with
budgeted or planned costs. Significant differences between planned and actual costs can then be
investigated and corrective action taken where appropriate.
Budgetary slack will lead to more favourable results when actual and budgeted costs are
compared. Corrective action may not be taken in cases where costs could have been reduced
and in consequence inefficiency will be perpetuated and overall profitability reduced.
Managers may incur unnecessary expenditure in order to protect existing slack with the aim of
making their jobs easier in future periods, since if the bias were detected and removed, future

14
budget targets would be more difficult to achieve. Any unnecessary costs will reduce the
effectiveness of cost control in supporting the achievement of financial objectives such as value
for money or profitability.
Where budgetary slack exists, managers will be less motivated to look for ways of reducing
costs and inefficiency in those parts of the organisation for which they bear responsibility. The
organisation’s costs will consequently be higher than necessary for the level of performance
being budgeted for.

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