ACCA P5 - Advanced Performance Management Passcards 2013-1
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Transcript of ACCA P5 - Advanced Performance Management Passcards 2013-1
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ACCAPAPER P5ADVANCED PERFORMANCEMANAGEMENT
PASSCARDS
FOR EXAMS UP TO JUNE 2014
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Professional Paper P5Advanced Performance Management
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First edition 2007, Seventh edition September 2012ISBN 9781 4453 9672 9
e ISBN 9781 4453 9233 2British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from theBritish Library
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Published byBPP Learning Media Ltd,BPP House, Aldine Place,142-144 Uxbridge Road,London W12 8AAwww.bpp.com/learningmedia
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All rights reserved. No part of this publication may bereproduced, stored in a retrieval system or transmitted, inany form or by any means, electronic, mechanical,photocopying, recording or otherwise, without the priorwritten permission of BPP Learning Media.
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2012
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Welcome to BPP Learning Medias ACCA Passcards for Professional Paper P5 Advanced PerformanceManagement.
They focus on your exam and save you time.
They incorporate diagrams to kick start your memory.
They follow the overall structure of the BPP Learning Medias Study Texts, but BPP Learning Medias ACCAPasscards are not just a condensed book. Each card has been separately designed for clear presentation.Topics are self contained and can be grasped visually.
ACCA Passcards are still just the right size for pockets, briefcases and bags.
ACCA Passcards should be used in conjunction with the revision plan in the front pages of the Kit. The planidentifies key questions for you to try in the Kit.
Run through the Passcards as often as you can during your final revision period. The day before the exam, tryto go through the Passcards again! You will then be well on your way to passing your exams.
Good luck!
ContentsPreface
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ContentsPreface
Page1 Introduction to strategic management
accounting 12 Performance management and control of
the organisation 173 Business structure, IT developments and
other environmental and ethical issues 234 Changing business environment and
external factors 395 Performance management information
systems 496 Management information, recording and
processing and management reports 597 Performance hierarchy 678 Scope of strategic performance measures
in the private sector 759 Divisional performance and transfer
pricing issues 85
Page10a Strategic performance measures
in not-for-profit organisations 9510b Non-financial performance indicators 10111 The role of quality in management
information and performance measurement systems 105
12 Performance measurement: strategy, reward and behaviour 121
13 Alternative views of performance measurement and management 131
14 Strategic performance issues in complex business structures 141
15 Predicting and preventing corporate failure 147
16 Current developments, issues and trends 153
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1: Introduction to strategic managementaccounting
Topic List
Planning, control, decision making andmanagement information
Corporate planning
Planning and control: strategic andoperational
Multinational aspects
SWOT analysis
Benchmarking
This chapter introduces strategic managementaccounting and how it fits into the planning and controlprocess of an organisation.
The chapter also explains how organisations set strategicplans and control their outcomes.
There is an explanation of some of the techniques usedto do this and some of the factors that affect strategicplanning.
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
The process of deciding on the objectives of theorganisation, on changes in these objectives, on theresources used to attain these objectives, and on thepolicies that are to govern the acquisition, use anddisposal of the resources.
Long term and wide scope Generally formulated in writing Widely circulated Doesnt trigger direct action, but series of lesser
plans Includes selection of products, purchase of non-
current assets, required levels of company profit
Characteristics of strategic informationStrategic planning
Strategic decisionsStrategic decisions are long-term decisions,characterised by wide scope, wide impact, relativeuncertainty and complexity.Most strategic decisions are unique, so theinformation needed to support them is likely to be ad-hoc and specially tailored to the decision.
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1: Introduction to strategic management accountingPage 3
Management controlThe process by which managers ensure thatresources are obtained and used effectively andefficiently in the accomplishment of the organisationsobjectives. It is sometimes called tactics or tacticalplanning.
Short-term and non-strategic Management control planning activities include
preparing annual sales budget Management control activities include ensuring budget
targets are (at least) reached Carried out in a series of routine and regular planning
and comparison procedures Management control information covers the whole
organisation, is routinely collected/disseminated, isoften quantitative and commonly expressed in moneyterms Cash flow forecasts Variance analysis reports Staffing levels
Source of information likely to be endogenous (fromwithin the organisation)
Characteristics of management accountinginformation
Management accounting information forstrategic planning and decision making Incorporates forecasts/estimates/risk and
uncertainty analysis Has an external orientation Forward looking and outward looking Helps to ensure goal congruence
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Long-term strategic plans can conflict with the shorter-term objectives of management control.
Performance measures/control measures do not take strategic direction into account.
Strategic imperatives might not be properly communicated to middle management.
Strategic planning information might be difficult to measure.
Management control and strategic planning compared
ExampleThe decision to launch a new brand of frozen foods is a strategic plan, but the choice of ingredients for themeals is a management control decision.
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1: Introduction to strategic management accountingPage 5
Performance managementActivity designed to improve anorganisations performance and ensurethat its goals are being met
Performance management systemsPlans, with set guidelines and targets, to helporganisations measure how efficiently goals are beingmet, and to identify areas where performance can beimproved
Organisation has to establish its goals andobjectives before it can assess whether theyare being met.
Once performance targets have been set, anorganisation can measure whether its goalsand targets are being achieved.
Often linked to employee reward programmesso employees are rewarded for helping anorganisation reach its goals.
Performance measurement is an importantcontrol in an organisation.
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Management control v operational control
Operational control/planningThe process of ensuring that specifictasks are carried out effectively andefficiently. Short-term and non-strategic
Occurs in all aspects of anorganisations activities andneeded for day to dayimplementation of plans
Often carried out at shortnotice
Information likely to have anendogenous source, to bedetailed transaction data,quantitative and expressed interms of units/hours
Includes customer orders andcash receipts
Characteristics of operationalcontrol
ExampleStrategic planSenior management decidesales should increase by 5% pafor at least five years.Management control decisionSales quotas are assigned toeach sales territory.Operational control decisionManagers of sales territoriesspecify weekly targets for eachsales representative.
Operational control decisions aremore narrowly focused, carried outwithin a shorter time frame and takenby managers less senior in theorganisation.Operational control focuses onindividual tasks whereasmanagement control is concernedwith the sum of all tasks.
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1: Introduction to strategic management accountingPage 7
Performance management systemsshould have clear links betweenperformance measures at the differenthierarchical levels of the organisation.
Means all departments and divisions willbe working towards the same ultimategoal.
Illustrated by performance pyramid (seechapter 13).
Strategic planning
Operational control
Managment control
Anthony hierarchy
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Overall strategicstance
Businesssunderlying values
and/or
Strategicanalysis
Companys internal resources andfacilities: current performance,
comparatives
POSITION AUDIT
eg PEST factors, competitive forces,turbulence
ENVIRONMENTAL ANALYSIS
eg Strengths, Weaknesses,Opportunities, Threats; Gap analysis
CORPORATE APPRAISAL
Why the business exists at allWhat the business is
MISSION
The relevance of the mission todifferent stakeholders
GOALS
How the mission can be achievedDesirable outcomes of corporate
activity
OBJECTIVES
Often the same.Terms used interchangeably.
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1: Introduction to strategic management accountingPage 9
Strategicchoice
Strategicimplementation
Options generation
Options evaluation
Choice
CORPORATE STRATEGIC CHOICE
1
2
3
eg Marketing strategies, productionstrategies
STRATEGY IMPLEMENTATION
Assess actual performance in thelight of plans etc
REVIEW & CONTROL
TACTICS ACTUAL PERFORMANCE
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Corporate Strategy
Operational/functionalStrategies
Business levelStrategy
Levels of strategyCovers business as a whole
Issues such as: diversifying or restricting activities investing survival or growth
How an organisation approaches a particular market
Choice of generic strategies: cost leadership differentiation focus
Involves decisions made at operational leveleg product pricing; personnel and recruitment
Operational strategies are crucial in implementingcorporate and business level strategies successfully.
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Linking strategy andoperations
The achievement of long-termgoals will require strategicplanning which is linked to short-term operational planning ... Ifthere is no link between strategicplanning and operationalplanning the result is likely to beunrealistic plans, inconsistentgoals, poor communicationand inadequate performancemeasurement.
Strategic planning and control versus operational planning and control
Strategic
Broad brush targetsWhole organisationExternal inputExternal focusFuture orientated, feedforwardcontrolPotential for double loopfeedback (ie opportunity tochange the plan)
Long term
Operational
DetailedActivities of departmentMainly internal informationInternal focus, on actual proceduresMore concerned with monitoringcurrent performance against planMainly single loop feedback(performance must change, not theplan)
Short term
Page 11 1: Introduction to strategic management accounting
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
Strategic controlTo encourage the measurement of theright things, organisations can instituteformal or informal systems of strategiccontrol. Formal systems require theidentification of milestones ofperformance (strategic objectives).
Focus on what matters in thelong term
Identify and communicatedrivers of success
Support organisational learning Provide a basis for reward Measurable Meaningful Acceptable Described by strategy and
relevant to it Consistently measured Re-evaluated regularly
Desirable features of strategicperformance measures
Linkages Diversity Criticality Change Competitive advantage
Guidelines for a strategic control system
The key to strategic control isensuring that the right thingsget measured.
False alarmsmotivate managers toimprove areas where thereare few benefits to theorganisation
Gaps are important areasthat are neglected (egcustomer satisfaction)
Different measures applyto different industries
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
1: Introduction to strategic management accountingPage 13
Cultural factors (eg international hasfragmented, diverse markets)
Economic factors (eg international hasmultiple (unstable?) environments)
Competitive factors (eg little informationabout many more competitors ininternational business)
Political factors (often significant ininternational businesses)
Technological factors (eg training problemsin international businesses)
Differences between domestic and internationalbusinesses
Establishing realistic standards Determining controllable cash flows Currency conversion Bases of comparison
Problems of performance measurement
Exchange rate fluctuations Risk Cost structure Accounting policies Transfer prices Workforce Government policy Life cycle Level of domestic competition
Examples of problems when setting objectives
Potential issues in managing foreign subsidiaries Planning: is strategic planning co-ordinated by corporate centre or at national level? Control: is control centralised or do foreign subsidiaries have autonomy?
Performance measurement
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
SWOT analysis How SWOT can guide strategy formulationA critical appraisal of the strengths andweaknesses, opportunities and threats inrelation to the internal and externalenvironmental factors affecting anorganisation, in order to establish its conditionprior to the preparation of a long-term plan.
Identify weaknesses which need to beaddressed
Identify key aspects of performance(CSFs) which need to be measured(through KPIs)
Help set targets (eg to take advantage ofopportunities)
Determine information needs (eg toreport on KPIs).
1 Match strengthswith marketopportunities
2 Convert weaknesses intostrengths and threats intoopportunities
Strengths Weaknesses
Opportunities Threats
Conversion
ConversionM
atc
hin
g
Internal to the company
Existindependently
of thecompany
SWOT and performance management
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BenchmarkingPlanning, control, decision makingand management information
Corporate planning
SWOTanalysis
Multinationalaspects
Planning and control:strategic and operational
1: Introduction to strategic management accountingPage 15
Functional
Internal Comparing one operating unit or function withanother in the same industryComparing an internal function with the bestexternal practitioners, regardless of industry
Competitor Gathering information about direct competitorsusing, for example, reverse engineering
Non-competitor Particularly relevant for not-for-profit organisations.Compare against organisations in the sameindustry although they are not competitors.
TTypes ofypes ofbencbench-h-
markingmarking
Benchmarking
The establishment,through datacollection, of targetsand comparators,which will allowrelative levels ofperformance (andparticularly areas ofunderperformance)to be identified. Byadopting identifiedbest practices, it ishoped thatperformance willimprove.
Provides basis for establishingstandards of performance
Sets targets that areachievable
Can be a spur to innovation
Advantages
Implies one best way of doing things Yesterdays solution for tomorrows problem Catching-up exercise Potential negative side effects of what gets
measured gets done.
Disadvantages
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Notes
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2: Performance management and control of the organisation
Topic List
Budgeting
Not-for-profit organisations
Beyond budgeting
Budgets are short-term plans which provide short-termtargets within the framework of the longer-term strategicplans (covered in Chapter 1). Some of the contents ofthis chapter are brought forward from earlier studies andwill provide background to exam problems on higher-levelbudgeting issues.
Not-for-profit organisations and their specific budgetissues are considered, before use look at the concept ofbeyond budgeting which tries to address some of theproblems faced in traditional budgeting.
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Not-for-profitorganisations
Beyond budgeting
Ensures organisations objectivesare achieved
Compels planning Communicates ideas and plans Coordinates activities Allocates resources Authorises expenditure Provides a framework for
responsibility accounting Establishes a system of control Provides a means of performance
evaluation Motivates employees to improve
performance
Uses of budgeting As a budget has different purposes, it mightmean different things to different people.
Forecast Yardstick Target Means of allocating resources
Incremental Flexible Zero based Rolling Activity based
Alternative budget systems
Budgeting
You should know the detailbehind the following points.
Long-term plan Limiting factor Budget manual Sales budget Production capacity Functional budgets Discretionary costs Consolidation and
coordination Cash budget Master budget
Prior knowledge
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2: Performance management and control of the organisationPage 19
Strengths and weaknesses
Zero-basedbudgeting
Rolling budget
Pros Easy to
prepare
Can beflexed toactuallevels
Encouragesslack
Doesnt lookto improveperformance
Assumes3Es in place
Responds tochanges inenvironment
Reviews costbehaviourclosely
Improvesefficiency ofresource allocation
Timeconsuming
Needstraining
Needs aparticipativeapproach
Pros Reduces uncertainty in
an unstableenvironment
Most recentplans used
Budgets alwaysseveral monthsahead
Pros ConsCons
Flexible budgeting
Identifiessparecapacity
Pros Cons
Cons
ABBPros Identifies critical
success factors
Looks at activity in depth
Cons Time consuming Difficult to identify
responsibility andaccountability foractivities
Incremental budging
Timeconsuming
Not necessaryin a stableenvironment
Managers may not see value ofcontinuousupdating
Prone to error if standardsincorrect
Irrelevant in a mainly fixedcost environment
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Not-for-profitorganisations
Beyond budgeting
Budgeting
Not-for-profit organisationAn organisation whose ... prime goal is not assessed byeconomic measures. Bois
Funding PlanningFunding comes from government rather than usersand is a political decision. So no clear linkbetween providing more service and funding.
Poor performance can lead to higher levels offunding
The political system affects planning. Changes inpriorities and funding can be imposed at will.
Limited control is offered over funding.
Budgeting in public sectorCharacterised by incremental, short-term (oneyear) bid budgets.
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Beyondbudgeting
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Not-for-profitorganisations
Budgeting
Beyond Budgeting
Two fundamental concepts underlie the BeyondBudgeting approach: Adaptive management processes Devolved organisation and decision making
Beyond Budgeting is a set of guiding principles thatpropose abandoning traditional budgets in favour of analternative general management model based ondecentralised decision making, personal respon-sibility, maximising value and adaptability to change.
Add little value
Waste valuable management time
Can result in dysfunctional behaviour
Conflict between communicating corporategoals and financial control
Often based on bargaining and not the bestmodel of resource consumption
Incompatible with a drive towards continuousimprovement
Insufficient external focus
Criticisms of traditional budgeting (Hope and Fraser)
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Not-for-profitorganisations
Beyond budgeting
Budgeting
Factor Traditional budgeting Beyond Budgeting
Time frame Short-term focus Longer-term focus
Basis of rewards Focus on individual departments and divisions; self-interestOrganisation viewed as one team.Focus on learning and innovation.
Strategic planning Company-led approach to strategicmanagementCustomer-led approach to strategic management
Resource allocation To operating units or departments Allocated to strategic initiatives rather than departments
Co-ordination Link functional budgets to one anotherDetermined by requirements to meet customer needs
Performance reports Primarily based on historical, financial indicatorsMultifaceted, multi-level information.Forward looking as well as historical.
Traditional budgeting and beyond budgeting compared
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3: Business structure, IT developments and other environmental and ethical issues
Topic List
Business structure/information
Business process re-engineering
Business integration
Teamwork and empowerment
Data and MIS
Stakeholders and ethics
In this chapter we look at the way businesses arestructured and how they co-ordinate their resources.We also look at how data systems and MIS provideinformation on changes happening in the organisation.Then we look at stakeholders, their roles and effect onthe organisation.Finally, we consider ethics, which is a vital component ofmodern organisational behaviour.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Business structureOrganisations vary in the way they arrange their activities. Differences in organisational structure affect informationneeds and how performance is measured.
Vertical flow Functions tend to be isolated
Information needs Performance measurement
Functionalform
Economies of scale Hard to identify results for individual
products or markets People don't understand how business
works as a whole
Lateral communication Information and advice rather than instructions and
commands Levels of information need: operational, financial,
management information
Freedom to set standards by divisionalmanagers
Tendency for centre usurp divisionalprofits
Divisional performance not direcltyassessed by markets.
Outsourcing of personnel and assetsis common
Functions and services sharedbetween organisations
Divisionalform
Networkform
Autonomy lower down the organisation Formal communication between centre and divisions Use of transfer prices to set performance standards
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
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Business process re-engineering
The fundamental rethinking and radicalredesign of business processes to achievedramatic improvements in criticalcontemporary measures of performance suchas cost, quality, service and speed.
Processes should be designed to achieve a desiredoutcome (rather than focus on existing tasks).
Personnel who use output from a process shouldperform the process.
There is no differentiation between informationgathering and information processing.
Geographically-dispersed resources should betreated as if they were centralised.
Parallel activities should be linked, not integrated. There is no distinction between workers and
managers. Information should be captured once, at source.
Principles of BPR which influence systemsdevelopment
A process is a collection of activities that takesone or more kinds of input and creates anoutput.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
ImplicationsImplicationsof BPR fof BPR fororaccountingaccounting
systemssystems
Performancemeasurement
Measures must be built around processes notdepartments. This may affect the design of responsibilityaccounting systems.
Reporting There will be a need to identify where value is beingadded.
Activity ABC might be used to model the business processes.
Structure Complexity of the reporting system will depend onorganisational structure.
Variances New variance analyses may need to be developed.
Business process re-engineering
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
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Business integrationAll aspects of a business mustbe aligned to secure the mostefficient use of the organisationsresources to achieve itsobjectives effectively.
McKinsey 7S modelThe McKinsey 7S model describes the links between the organisationsbehaviour and the behaviour of individuals within it.
Hard
Soft
SHAREDVALUES
STRUCTURE
STAFF
STYLE
SYSTEMSSTRATEGY
SKILLS
Four particular aspects of linkagehighlighted in the P5 syllabus: People Operations Strategy Technology
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
People implement the strategyand enable the organisation to
pursue its mission: humanresources; motivation
People mustbe to use
technology effectivelytrained
Techno
logy e
nables
new str
ategic
option
s
to be p
ursued
Strategy is made or brokenat operational level
Technologyfacilitatesoperations
People
Technology
Strategy
Operations:Most people work here
THE CUSTOMERINTERFACE
Linkage between people,operations, strategy andtechnology
People issues Quantity Motivation Skills level Deployment
Strategy issues Direction Implications for resources
Operations issues Procedures Customer relations Empowerment Quality
Technology issues Equipment Information Work organisation
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Value chainThe value chain is another model for looking atbusiness integration. It provides an overall perspectiveof the activities of the business, which might easily beseen in isolation in functional departments.
The ultimate value a firm creates is measured by theamount customers are willing to pay for itsproducts/services above the cost of carrying outvalue activities.
To be successful, anorganisation needs toensure that thecharacteristics of all ofits activities areconsistent with eachother.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Characteristics of information needs of a team-based/empowered organisation
Mixture of financial and non-financialinformation. Teams carry out activities but maynot know the financial implications.
Transparency and immediacy. Teams needinformation quickly if they are to work flexibly.
Common data definitions. These are necessaryto enable comparison between teams.
Relevance Aggregation. It should still be possible to obtain a
broad view of how the organisation is doing. Responsibility centres. A budget for each team
might be required, as determined by theactivities in which it is involved.
Impact ofImpact ofempoempowermentwerment
on manaon managg ementementaccountingaccounting
systemssystems
Information must be disseminated throughout the organisation rather thanhanded down through the hierarchy.
Employees need to be given responsibility and the authority to make decisionswithin defined parameters.
Rather than issue orders, managers must be able to create conditions in whichthe organisation can prosper and front line staff must be able to deliverappropriate customer service.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
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Consideration of Information needs formanufacturing business
Characteristics that distinguish services frommanufacturing
Cost behaviour Innovation Quality Valuation Time
Inseparability/simultaneity Variability/heterogeneity No transfer of ownership
Perishability Intangibility
Information forservice businesses
Small service businesses, whose expenses aremainly overheads, provide a model in miniature ofthe requirements of activity based costing (ABC).
Service industries in particular rely on their staffand so management information must includeintangible factors such as how customers feelabout the service, as well as the key drivers ofservice costs (eg repeat business, churn rate).
The information required may varydepending on whether theorganisation offers mass servicesor personal services.
Operational information is likely tobe largely qualitative.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Remote input of data Instant access to data
Via distribution of data
Word processing Electronic schedules Desktop databases Web publishing Voicemail E-mail
Officeautomationsystems
Via sharing of data
Groupware
Intranets
Extranets
Software that can be used by collaborative work groups (messaging, views of an informationdatabase, public folders)
Internal networks used to share information. Remote access is quick and easy.
Network accessible to authorised outsiders. A popular means for business partners toexchange information.
A number of data capture techniques allow staff toinput data to the organisations system whether ornot they are in the office.
Laptop computers Bar coding and EPoS devices
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Databases Provide comprehensive files of data for a number of different users. Avoid data redundancy andwastage of space, and reduce errors/inconsistencies from multiple data input.
Databasemanagement
systems(DBMS)
Software systems which organise the storage of data in a database in the most appropriateway.
Datawarehouses
Contain data from a range of internal and external sources. Query and reporting tools facilitatemanagement reporting and analysis.
Datamining Software which looks for different (sometimes previously unknown) patterns in groups of data(eg retail companies can find customers with common interests).
Enterpriseresourceplanning(ERPS)
Packages which aim to integrate all of an organisations applications (including manufacturing,distribution, inventory, invoicing, accounting, HRM, marketing) to give a single point of access.Link business processes and financial control, so can support management tools such as theBalanced Scorecard.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Management information system (MIS)A system to convert data from internal and externalsources into information and to communicate thatinformation, in an appropriate form, to managers atall levels in all functions to enable them to maketimely and effective decisions for planning, directingand controlling the activities for which they areresponsible.
Not all information will be collected and processed(but will be kept in managers heads).
Information will not be disseminated to appropriatemanagers.
Communication of information will not be timely.
Consequences of MIS development withoutformal planning
Dissatisfaction among employees who believe theyshould be told more
Lack of understanding of what targets to achieve are Lack of information about how well work is being
carried out
Consequences of a poor MIS
Definition of functions of individuals and their areasof responsibility in achieving objectives
Definition of areas of control within the organisation Information required for an area of control should
flow to the manager responsible for it
Essential characteristics of an MIS
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3: Business structure, IT developments and other environmental and ethical issuesPage 35
Decision support systems Expert systems Executive information systems
Modelling systems More competition requires better competitor intelligence Faster response means information must be produced
quickly and be up to date
Examples of impact of increasing competition
Increasing competition as above Behavioural impact on management accounting system
of operating in different markets
Examples of impact of increasing globalisation
Factors to consider when setting up a management accounting system (just one part of an overall MIS) Output required (identify the information needs of managers) When the output is required Sources of input information
Management accounting systems
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Groups or individuals whose interests aredirectly affected by the organisations
activities
Stakeholders
ExampleInternal Employees, managementConnected Owners, investors,
suppliers, customers,lenders
External Government, localcommunities, pressuregroups, unions
A: Minimal effort B: Keep informed; little
direct influence but mayinfluence more powerfulstakeholders
C: Treat with care; oftenpassive but capable ofmoving to segment D;keep satisfied
D: Key players strategymust be acceptable tothem, at least
Level of interestHighLow
Low
High
PowerA B
C D
Stakeholder mappingStakeholders interests are likely to conflict. Stakeholder mapping helps theorganisation to establish its priorities and set up its system of corporategovernance.
Remember: Relationship between stakeholders and organisation is two-way. Stakeholders can influence an organisation'sperformance, but an organisation's performance also affects its stakeholders.
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3: Business structure, IT developments and other environmental and ethical issuesPage 37
The extent to which an organisation will exceed itsminimum obligation to stakeholders.(Johnson, Scholes &Whittington)
Conflicting views of the organisations responsibilitiescreate ethical dilemmas for managers at all levels.
Short-term stakeholder interest: obey the letter of thelaw
Long-term stakeholder interest: behave ethically toenhance image and reduce pressure for regulation
Multiple stakeholder obligations: the expectations ofother groups of stakeholders may be considered, as wellas any right they may have
Shaper of society: ensuring society benefits fromactions is more important than financial and otherstakeholder interests (eg for public sector organisations)
Dealing with corrupt or unpleasant regimes Honesty in advertising Employees cost or asset? Corrupt payments to officials extortion, bribery or
gift? The local culture must be considered.
Ethical stance Ethical dilemmas
Corporate ethicsHas three contexts: interaction with society, effects ofroutine operations, behaviour of the individuals.
Ethics are ideas about right and wrong that set standards for conduct. Ethics are important to business becausesociety considers such things important. There are also rules of professional conduct to consider. Ideas of right andwrong have become more fluid and less absolute. As a result there is a greater scrutiny of organisations behaviour
since it is likely to be less subject to definitive internal rules.
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Stakeholdersand ethics
Data andMIS
Businessstructure/information
Teamwork andempowerment
Businessintegration
Business processre-engineering
Employees and management Shareholders
Consumer groupsSuppliers
Government
Organisations should seek to align the interests oftheir staff with those of the organisation (eg throughreward systems)
Shareholders often take a short-term view of theirinvolvement in an organisation.
Central government sets the regulatory framework.Local government has devolved powers and localinfluence (eg local taxes)
Consumerism reflects the increased importanceand power of consumers. Highlights that consumersatisfaction is likely to be crucial to long-termprofitability.
Can influence the cost and quality of goods andservices
Stakeholders and business performance
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4: Changing business environment and external factors
Topic List
Changing business environment
Risk and uncertainty
Factors to consider when assessingperformance
Government regulation
In this chapter, we look at the economic, fiscal andenvironmental factors which affect strategicmanagement. Businesses need to consider the risks anduncertainty from these external factors in their strategicdecision-making, and we also look at some aspects ofrisk and uncertainty in this chapter.
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
Manufacturingorganisations
Service organisations
Product life cycles
ThenPre 1970s, there was little internationalcompetition, costs were passed on tocustomers, minimal efforts were made tomaximise efficiency/reduce costs/improvemanagement practices.
Pre 1980s, many were government-ownedmonopolies or protected by highly regulated,non-competitive environments. Costincreases were covered by increasing prices.Cost systems were not deemed necessary.
Organisations could rely on years of highdemand for products.
NowThere is massive internationalcompetition, and global networksfor acquiring raw materials anddistributing high quality, low-pricedgoods.
Privatisation and deregulation hasresulted in intense competition, anincreasing product range and aneed for sophisticated costingsystems.
Competitive environment,technological innovation anddiscriminating and sophisticatedcustomer demand require continualproduct redesign and quick time tomarket.
Changing competitive environment
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Changing customer requirementsSuccessful organisations make customer satisfactiontheir priority.
Manufacturing processes must be sufficientlyflexible both to accommodate new productdesign and to satisfy the demand for greaterproduct diversity.
Traditional manufacturing systems
Jobbing industries
Batch processing
Mass/flow production
Recent developments
Group technology/repetitive manufacturing
Dedicated cell layout
Changing manufacturing systems
Cost efficiency
Quality
Time
Innovation
Key success factors
Continuousimprovement
Employeeempowerment
Total value chainanalysis
New managementapproaches
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
Be innovative and flexible Be able to deal with short product life cycles Be able to offer product variety whilst maintaining
or reducing costs Reduce set-up times and inventories Have the greatest possible manufacturing flexibility
To compete, organisations need to......
Materials requirement planning (MRPI) Manufacturing resource planning (MRPII) Enterprise resource planning (ERP) Optimised production technology (OPT) Just-in-time (JIT)
Production management strategies linked toAMT
Production management strategies
Computer-aided design (CAD) Computer-aided manufacturing (CAM) Flexible manufacturing systems (FMS) Electronic data interchange (EDI)
Advanced manufacturing technology (AMT) helps them to do this.
The traditional approach to determining materialsrequirements is to monitor the level of inventories constantlyso that once they fall to a preset level they can be re-ordered.This ignores relationships between different inventory lines(demand for a particular item is dependent on demand forassemblies/subassemblies of which it forms a part).Modern computer techniques integrate such relationships
into the inventory ordering process.
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
4: Changing business environment and external factorsPage 43
Risk and uncertainty
Physical (eg earthquakes, fire, equipment breakdown) Economic (not even government forecasts are perfect) Business (eg new competitors) Product life cycle (different risks exist at different stages) Political (eg sanctions) Financial (eg risk to stakeholders caused by debt
finance)
Types of risk and uncertainty
Strategic planning deals with future events: the futurecannot be predicted.Strategic planning is therefore susceptible to risk anduncertainty, much of which is exogenous.
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
Expected valuesThe expected value (EV) of a decision is calculated asEV = px
where p = the probability of an outcome occurring,and x = the value (profit or cost) of that outcome.
Risk preferenceDecisions will be influenced by stakeholders appetitesfor risk and their attitude to risk.
Decision-makers attitudes to risk can also influencethe way they analyse potential business decisions.
Decision-makers have to consider the potentialupsides and downsides of a particular course ofaction.
Their attitude to risk can determine the decision-making criteria they think are most appropriate:
Maximin (Maximising the minimum profits) Maximax (Maximising the maximum profits) Minimax regret (Minimising the regret from
making the wrong decision)
Risk seeker Risk neutral Risk averse
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
4: Changing business environment and external factorsPage 45
The main factors in the macro-environment which canaffect an organisation's performance can be identifiedusing PEST analysis
Political Economic Socio-cultural Technological
Collectively, these factors represent opportunitiesand threats an organisation could face
The level of competition in an industry affects theindustrys ability to sustain profits.
The level of competition is determined by
Five competitive forces:
The threat of new entrants The threat of substitute products or services The bargaining power of customers The bargaining power of suppliers The rivalry amongst current competitors in the
industry
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
ExamplesEconomic Consider local economic trends interest and exchange rates and inflationInflation Is inflation driving up wage rates or being caused by pay settlements?Legal Consider the impact of employment law or industry regulators.Political Is government policy affecting competition? Are incentives being offered to locate in a
particular area?EU Think about product standards and labour costs.Cultural These can affect the motivation and satisfaction of employees, the adaptability of the
organisation and its image.Businesscycle Is the economy booming or in recession?When comparing performance across different countries, consider problems such as distance and remotenessof divisions from HQ, transfer pricing difficulties, currency exchange rate fluctuations and variation inmanagement and worker skills.
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Factors to consider whenassessing performance
Changing businessenvironment
Governmentregulation
Risk anduncertainty
4: Changing business environment and external factorsPage 47
Types of organisation under government regulation Types of regulations by regulators
Purpose of regulations
Business eg Royal Mail operates on acommercial basis in the UK
eg NHS in the UK
National security
eg Water firms in the UK arestill, effectively, monopolies
eg British Telecom in the UK
Free at delivery
Public good
Privatised utility
Privatised utilitywith competition
Regulation of supply
Regulation of quality
Regulation of prices
Promote competition Protect customer welfare Use private cash to enhance quality Reduce public spending Ensure government subsidies are well spent
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Notes
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5: Performance management informationsystems
Topic List
Accounting information needs
Management accounting information
Management accounting systems
This chapter introduces management accounting andinformation systems, and how they could be used tomeasure performance.
Remember that we looked at strategic planning,management control and operational control informationin Chapter 1.
A variety of topics are considered, including the type oforganisation and the objectives of managementaccounting information.
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Managementaccounting systems
Managementaccounting information
Accountinginformation needs
Management accountinginformation can be used to supportstrategic planning, control anddecision making.
Strategic management accountingdiffers from traditional managementaccounting because it has anexternal orientation and a futureorientation.
Analysis of competitors costs Product profitability Customer profitability Pricing decisions Cost/benefits of capacity expansion Analysis of decisions to enter (or leave) a business area Brand values Shareholder wealth Impact of acquisitions and mergers Analysis of competitors potential reactions to a strategy
Examples of strategic management accounting
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5: Performance management information systemsPage 51
Management controlThe process by which managers ensure that resourcesare obtained and used effectively and efficiently in theaccomplishment of the organisations objectives. It issometimes called tactics or tactical planning.
Short-term and non-strategic Management control planning activities include
preparing annual sales budget Management control activities include ensuring
budget targets are (at least) reached Carried out in a series of routine and regular
planning and comparison procedures Management control information covers the
whole organisation, is routinelycollected/disseminated, is often quantitative andcommonly expressed in money terms Cash flow forecasts Variance analysis reports Staffing levels
Sources of information likely to be endogenous(from within the organisation)
Characteristics of management control
Management control decisions need tosupport an organisations strategic plans.
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Managementaccounting systems
Managementaccounting information
Accountinginformation needs
Operational control/planningThe process of ensuring that specifictasks are carried out effectively andefficiently.
Short-term and non-strategic Occurs in all aspects of an
organisations activities andneeded for day to dayimplementation of plans
Often carried out at shortnotice
Information likely to have anendogenous source, to bedetailed transaction data,quantitative and expressed interms of units/hours
Includes customer orders andcash receipts
CharacteristicsExampleStrategic planSenior management decidesales should increase by 5% pafor at least five years.Management control decisionSales quotas are assigned toeach sales territory.Operational control decisionManagers of sales territoriesspecify weekly targets for eachsales representative.
Management control v operational controlOperational control decisions are morenarrowly focused, carried out within ashorter time frame and taken bymanagers less senior in theorganisation.Operational control focuses onindividual tasks whereas managementcontrol is concerned with the sum of alltasks.
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Managementaccounting information
Managementaccounting systems
Accountinginformation needs
5: Performance management information systemsPage 53
Measure performance Plan for the future Control the business Make decisions
What management accounting information helps managers to do(its objectives)
Management accounting information is used for score keeping, problemsolving and attention directing.
Forward looking Neutral (free from bias) Financial, non-financial, quantitative or qualitative
Features that characterise management accounting information inparticular
Relevant Complete Accurate Clear Usable with confidence Appropriately
communicated (to theright person using thecorrect method)
Manageable volume Timely Cost effective
Good information
Information requirements vary significantly across different types oforganisational structure (eg functional basis vs network organisation).
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Managementaccounting systems
Managementaccounting information
Accountinginformation needs
Open and closed systemsA closed system is isolated and shut off from theenvironment, is unaffected by the environment, andcannot influence the environment.
An open system is connected to and interacts withthe environment and is influenced by it.
Enterprise Resource Planning Systems (ERPS)Management accounting systems do not exist inisolation, but are part of the wider information systemsin an organisation; exemplified by ERPS.
ERPS are software systems designed to support andautomate the business processes of medium-sized andlarge organisations. They aid the flow of informationbetween business functions within an organisation, andcan manage connections to outside suppliers.
All departments that are involved in operations orproduction are integrated in one system. As a result,organisations are more agile in the way they useinformation, can process information better, and canintegrate it into business procedures and decision-making more effectively.
Performance management:Organisations should adopt an open systemsapproach to performance management
eg organisational performance could be affected bycompetitors actions. Also, performance often cannotbe attributed to one single issue, but needs to beviewed as the combined effect of many variables.
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Lean management information systems Application of lean to MI systemsKey characteristics of lean systems:
Continuous improvement Increased productivity Improved quality Improved management
But note: to be successful, lean techniquesmust involve a commitment to adding value andeliminating waste. They cant be used simply asa justification for cost-cutting.
Lean can:
Enhance the value of data in the system:how it is organised, exchanged and retrieved
Add value to information through the way itis organised and presented (eg excludeunnecessary detail)
Enable information to flow to users moreefficiently.
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Managementaccounting systems
Managementaccounting information
Accountinginformation needs
The contingency approach to management accounting is based on the premise that there is no universallyappropriate accounting system applicable to all organisations in all circumstances. Efficient systems dependon awareness by the system designer of the specific environmental factors which influence their creation.
Predictability Competition Number of different product markets Hostility of competitors
Contingent factor - the environment
Size Interdependence of parts Degree of decentralisation Availability of resources
Contingent factor - organisationstructure
Nature of production process Complexity of production
process Task variety
Contingent factor - technology
Contingency approach
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Impact of human behaviour.
Allocating responsibility Encouraging participation in decision making Devising ways of measuring and rewarding
behaviour that contribute to organisationalobjectives
Methods
Management accounting systems have to developways of overcoming the problems of humanbehaviour.
Issues for management accountants:
Dual process frameworkheuristic/holisticprocessing analytical/systematicprocessing
Ways of presenting information:
Written format Tables Graphs or charts Dashboards Interactive reports
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Managementaccounting systems
Managementaccounting information
Accountinginformation needs
Responsibility accountingRole of management accountant
Learn from managers of responsibility centreswhat information they need, in what forms andwhat intervalsDesign a system that enables this information tobe provided (using different responsibility centres(cost, profit and so on))
A system of accounting that segregates revenuesand costs into areas of personal responsibility inorder to monitor and assess the performance of eachpart of an organisation.
Any part of an organisation which is headed by amanager who has direct responsibility for itsperformance.Responsibility accounting is based on the
principle of controllability.
But in practice is it always possible to splitimpacts on performance into controllable anduncontrollable categories?
Responsibility accounting
Responsibility centre
Important to distinguish between division'sperformance and managers performance. Can onlyevaluate manager's performance on factors he orshe can control.
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6: Management information, recording and processing and management reports
Topic List
Internal sources of information
External sources of information
Recording and processing methods,systems and data
Controls and security
Output reports
External information is vital for strategic planning andperformance feedback but is rarely directly input into themanagement accounting system.Internal information provides the input data for themanagement accounting system and is vital formanagement control and operational control. Control isdependent on the receipt and processing ofinformation.Also, the way in which information is presented is important.If the outputs from a management information system arenot accessible to the relevant people, the usefulness of theinformation is severely reduced.You are likely to encounter issues about controls andsecurity over data in your own workplace, but its worthreminding you about them here anyway.
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
Financial accounting records Systems of control over transactions
(eg inventory control systems) Payroll, production records, timesheets Staff (collected formally or informally)
Principal internal sources of managementaccounting information
Costs of the collection, processing and productionof internal data
Direct data capture costseg use of barcoding
Processing costseg inputting data to the MIS
Cost of inefficient use of informationeg information disseminated more widelythan needed
In todays competitive market, where the paceof change in information systems andtechnology is rapid, organisations must beflexible enough to adapt to change quickly andmust plan for expansion, growth and innovationwithin information systems.
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
6: Management information, recording and processing and management reportsPage 61
External information is used to different degreesdepending on the level and type of decision.
INTERNALEXTERNAL
Operational Tactical Strategic
Business directories Associations Government agancies Consumer panels Customers Suppliers Internet Databases Market research Data warehouses (internal + external sources)
Common external sources of information
External information can contribute to planning (eg market research informing sales budgets),decision-making (eg through competitor research)and control (eg from benchmarking.)
External information is used in the management accounting system depending on its quality. Quantitativedata is easier to use. Benchmarking uses external information to help set targets.
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
Costs associated with external sourcesDirect search costseg subscriptions to magazines
Indirect access costseg spurious accuracy
Management costseg wasted time on excessive processing
Infrastructure costseg maintenance of computer server
Time thefteg information overload
May not be entirely relevant Bias Accuracy should be questioned May not be available in correct form Can be expensive
Disadvantages
Note that the costs of market research can beconsiderable and that the internet can significantlyreduce search time and search costs.
Save time and money as secondary data ischeaper than primary
Advantages
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
6: Management information, recording and processing and management reportsPage 63
. . . But: beware the dangers of information overload given the volume of potential information available.
Different types of business will require different recording and processing methods butthe methods used should suit the volume of data (eg batch processing at the end ofthe day for a small bookshop), the level of accuracy required and the speed with whichthe information is required (eg EPoS devices, and real-time inventory updating insupermarkets).
Spreadsheet packages WiFi Database packages Radio-frequency identification Software packages (RFID) E-mail systems ERPS Computer Telephony Electronic data interchange (EDI)
Integration (CTI)
IT developments which have influenced recording and processingsystems
Given that qualitative data issubjective and judgmental, itsrecording is likely to beproblematic. The number of salesmade is easy to record; thereasons why sales are lost is not.
Qualitative data
General rule: any information that isneeded should be recorded and storedin such a way that it can be readilyretrieved.
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
Controls required over the generation ofinternal information
In routine reportseg consistent format to ensureaccuracyIn ad-hoc reportseg ensure information does notalready exist in another formatOver distributing internal informationeg procedures manualsOver information held on serverseg passwordsOther controlseg email policy
Passwords Firewalls Logical access systems Encryption Database controls Authentication
inference controls Anti-virus and anti-spyware passwords software
Personnel security planning
Procedures to ensure the security of highly confidentialinformation that is not for external consumption
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DashboardsDashboards are executive information systems which illustrate howa business is performing and help managers make better decisions,through showing current data, pictures, graphs and tables, therebyreducing the numbers (and size) of paper reports which have to beproduced.
Drill-down reportsDrill-down reports allow users to look at increasingly detaileddata about a situation.
Exception reportsOne way of reducing the amount of information being presented(thereby preventing overload) is through using exception reports.Reports are only triggered when a situation is unusual orrequires management action.
Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
6: Management information, recording and processing and management reportsPage 65
As the volume of data available tobusiness increase, it is important thatthey ensure this data is 'fit forpurpose.'
'Fitness for purpose' involves databeing accurate and relevant withoutbeing overwhelming.
Similarly it is important that outputreports are timely, accurate andtailored to the user.
Beware of the dangers ofinformation overload.!
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Recording and processing methods, systems and data
Controls andsecurity
Output reportsExternal sourcesof information
Internal sourcesof information
Recap: Overview of management information systems
Feedback is crucial for control, eg through comparing actual results to plan, and identifying variances.
PROCESSING
STORAGE
OUTPUTINPUT
FEEDBACK
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7: Performance hierarchy
Topic List
Mission statements and vision
Goals and objectives
Short term and long term
Filling the planning gap
Planning/controlling at different levels
In this chapter we start looking at strategic performancemeasurement techniques and the issues relating tostrategic performance measurement.
Although we will look at some important aspects ofstrategy in this chapter, please remember that the focusof paper P5 is on performance (performancemeasurement, and performance management) ratherthan strategy itself.
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Short term andlong term
Planning/controllingat different levels
Filling the planning gap
Goals and objectivesMission statementsand vision
Describes the organisations basic function in society,in terms of the products and services it produces forits clients. Explains what the business is for.
MissionA formal statement of an organisations mission
Mission statement
Purpose Policies and standards of behaviour Strategy Values and culture
Elements of mission
VisionIf a mission answers the question What is thebusiness for?, a vision answers the question Whereis the business going?
A vision gives a general sense of direction to thecompany.
There is no standard format but mission statementsshould be brief, flexible, distinct and open-ended.
Business areas in which the organisation willoperate
Organisations reason for existence Stakeholder groups served by the organisation
Factors to incorporate in a mission statement
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Short term andlong term
7: Performance hierarchyPage 69
Planning/controllingat different levels
Filling the planning gap
Goals and objectivesMission statementsand vision
Goals are derived from an organisations vision and mission. Operational goals can be expressed as quantified,SMART (Specific, Measurable, Attainable, Relevant, Time-bounded) objectives.
ExampleA mission might be to deliver a quality service, a goal to enhance manufacturing quality and an objective toreduce the number of defects to one part per million over the next year.
Corporate objectives Strategic objectives Subsidiary objectives
ExampleIf a primary objective is growthin profits, strategies by whichthe primary objective can beachieved (eg for growth in
sales) must be developed.
Unit objectives Ranking objectives
These primary objectivesconcern the organisation as awhole (eg profitability, industrialrelations) and are set as part ofthe corporate planning process.
These are specific to individualunits of an organisation.
These combine to ensure theachievement of the primarycorporate objective.
These are developed beneath strategicobjectives.To ensure co-ordination, the various functionalobjectives must be interlocked vertically,horizontally and over time.
Multiple objectives can clash so strategicmanagement must ensure goal congruence.
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Short term andlong term
Planning/controllingat different levels
Filling the planning gap
Goals and objectivesMission statementsand vision
Hierarchy of objectives Social and ethical obligationsMission
Goals
Objectives
Strategy
Tactics
Operational plans
Increasingcoverageof aspects
of theorganisation
Each level of the hierarchy derives its objectives from the level above, so ultimately all are founded in the mission.Objectives therefore cascade down the hierarchy so that, for example, strategies are set to achieve objectives,and provide targets for tactics. Again, this highlights the importance of goal congruence across different levels.
To internal stakeholders (employees, management) To connected stakeholders (shareholders, customers,
suppliers, financiers) To external stakeholders (the community, government,
pressure groups)Whereas social responsibility deals with the organisationsgeneral stance towards society, and affects the activities theorganisation chooses to do, ethics relates more to how anorganisation conducts individual transactions.
Corporate codes of conduct contain statements setting outcompany values and responsibility toward stakeholders.
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7: Performance hierarchyPage 71
Objectives, CSFs and KPIs Objectives
Critical Success Factors (CSFs)
Key Performance Indicators (KPIs)
CSFs are the key factors and processes an organisation needs toexcel at in order to achieve its objectives.
KPIs measure how well an organisation is performing against itsCSFs.
Impact on information systems.
CSFs identify the areas of performance which managers need information about. Therefore it is important thatinformation systems can provide managers with this information (eg, the systems can provide information forKPIs.)
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Short term andlong term
Planning/controllingat different levels
Filling the planning gap
Goals and objectivesMission statementsand vision
Postpone/abandon capital expenditure
Cut R&D expenditure
Reduce quality control
Reduce the level of customer service
Cut training costs/recruitment
Decisions which involve the sacrifice of longer-term objectivesfor short-term benefit
Make short-term targets realistic. Provide sufficient information to
allow managers to see what S/Ltrade-offs they are making.
Evaluate managerial performancein terms of contribution to long-term as well as short-termobjectives.
How to control short termism
Refers to the balance of organisational activities aiming to achieve long-term and short-term objectives whenthey are in conflict or where resources are scarce
S/L trade-off
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Filling the planning gap
Short term andlong term
7: Performance hierarchyPage 73
Planning/controllingat different levels
Goals and objectivesMission statementsand vision
Incremental improvements to currentactivities (eg cost reduction)
Combination of market penetration, marketdevelopment, product development anddiversification (Ansoffs matrix)
Withdrawing from a business (if it is loss-making); divestment
Acquisition Internally-generated (organic) growth
How to fill the gap$000
Planning gapThe planning gap is the gap between the forecast position from continuing with current activities, and theforecast of the desired position.
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Planning/controllingat different levels
Short term andlong term
Filling the planning gap
Goals and objectivesMission statementsand vision
Level ControlsPlansCorporate/strategic Focused on overall performance
Influenced by external environment Set plans/targets for units/departments Sometimes qualitative Aggregate
Operational
Exercised by external stakeholdersand/or the market
Double-loop feedback (ie relatively freeto change targets)
Often feedforward elements Based on objectives about what to
achieve Specific Little immediate environmental influence Likely to be quantitative Detailed specifications Based on how something is achieved Short time horizons
Exercised internally by management orstaff in empowered teams
Immediate or rapid feedback Single loop feedback (ie little authority
to change plans or targets)
Operational performance is customer-facing (in services), specialised, more likely to be routine, limited inscope, characterised by short time horizons and easier to automate than some management tasks.
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8: Scope of strategic performance measuresin the private sector
Topic List
Shareholders, survival and growth
Profitability
Gearing
Liquidity
Performance and share value
Comparisons
The profit-making or private sector tends to favourfinancial performance measures whereas the publicsector favours non-financial indicators. There are fourmain groups of financial performance measures: growth,profitability, gearing and liquidity.
You also need to be clear about the distinction betweenshort-run and long-run performance measures.
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Shareholders,survival and growth
Profitability Performance andshare value
Liquidity ComparisonsGearing
An organisation must make sustainable profits
Revenue Number of employees ROI Number of products Market share Cash flow
Other ways of measuring growth
Why are shareholders important? Survival and growthThe clearest measure of success for a business is continuedexistence and expansion.
Growth requires profits Growth produces profits Growth without profits no survival*
Problems in attaining goal congruenceare often due to difficulties in satisfyingdiffering objectives of the organisationsvarious stakeholder groups. Shareoptions are one way of aligningshareholder and managerial goals.
Profit-making organisations tend tofocus on financial performance ingeneral and on the interests ofshareholders in particular. The argumentfor this is that shareholders are the legalowners, the company belongs to themand so their interests are paramount.
* But beware there could be conflicts between a business strategy aimed at growth and a strategy aimed at survival.
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ROCE
Shareholders,survival and growth
Profitability Performance andshare value
Liquidity ComparisonsGearing
8: Scope of strategic performance measures in the private sectorPage 77
Calculated as (gross profit/turnover) 100%(where gross profit = sales cost of sales)Influenced by the level of fixed costsNot useful for comparing different industries
Earnings before interest, tax, depreciation andamortisation.It is a good proxy for cash flow from operations and so can beused as a measure of underlying performance.Tax and interest are not relevant to an organisationsunderlying success.Depreciation is not relevant to performance in a particular year.It is easy to calculate and understand.
EPSShows how well the shareholder is doing.Calculated as (profit after tax, MI, extraordinaryitems and pref div)/no of equity shares.Must be seen in context as on its own it does notimpart much information.Easily manipulated by changes in accountingpolicies/mergers/acquisitions (especially forbonuses).
Calculated as (PBIT/capital employed) 100%Capital employed = share capital and reserves +long-term liabilities and debt capitalROCE = profit margin asset turnover
Sales margin
EBITDA
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Shareholders,survival and growth
Profitability Performance andshare value
Liquidity ComparisonsGearing
NPV/IRR/MIRR.
Definition/valuation of assets.
Fair performance comparisons with othercentres.
It can give a false impression of improvingperformance over time.
It can discourage new investment.
Group target returns may be unsuitable forthe entire group.
Target returns can produce a lack of goalcongruence, short termism anddysfunctional decision making.
Problems with the use of ROI
Focus on future cashflows and allow for risk(through use of discount factors)
It is calculated as profit imputed interest (whereimputed interest is capitalemployed cost of capital).
It overcomes some of theproblems of ROI but it has its owndisadvantages.
ROI
RI
ROI is a form of ROCE used forinvestment centres.
It is calculated as (PBIT/operations management capitalemployed) 100%.
MIRR distinguishesbetween investmentphrase and returnphase of a project, toovercome the flawedassumption made inIRR that cash flowsare reinvested at theprojects IRR over thelife of the project.
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Economic value added (EVA)EVA is similar to RI because it is an absoluteperformance measure calculated by subtractingan imputed interest charge from the profitearned by a company or division.
EVA = net operating profit after tax (NOPAT)less capital charge.
Capital charge = weighted average cost ofcapital net assets.
However, EVA looks to measure specificallyhow well companies are maximising thewealth of their shareholders. Argues thattraditional profit-based measurement do not dothis.
EVA is based an economic profit which is not thesame as accounting profit:
Value-building expenditure (eg advertising) isadded back to profit
Non-cash items are eliminated
One-off, unusual items are excluded
Charge for accounting depreciation is added back toprofit (under EVA) and a charge for economicdepreciation made instead.
Capital charge uses different bases for net assets.EVA usually uses replacement cost of assets.
Key differences between EVA and RI
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GearingShareholders,survival and growth
Profitability Performance andshare value
Liquidity Comparisons
Measures of financial gearingPrior charge capital
Equity capital (incl reserves)
Prior charge capitalTotal capital employed
Financial gearingA high level of debt creates financial risk in a companys capital structure.
The company: if debts cant be paid it may be forced into liquidation. Suppliers: they are unlikely to recover in full the money they are owed. Shareholders: they can expect lower or non-existent dividends if high interest payments are made.
Financial risk from different points of view
Operating gearing
Gearing measures the relationship between shareholders capital plus reserves, and either prior charge capital orborrowings or both.
Operating gearing is concerned with the relationshipbetween the variable cost/fixed cost operating structureand profitability.Gearing ratio = contribution/PBIT
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Shareholders,survival and growth
Profitability Performance andshare value
Liquidity ComparisonsGearing
8: Scope of strategic performance measures in the private sectorPage 81
A company must be liquid so that it can meetits debts when they fall due.
A company can be profitable but at the sametime have cash flow problems.
Liquid funds consist of cash and short-terminvestments for which there is a ready market +fixed-term bank/building society deposits + tradereceivables + bills of exchange receivable.Some assets are more liquid than others.Non-current assets are not liquid assets.Liquid assets = all current assets or all currentassets with the exception of inventory.
Ratios to assess liquidity
Current assets current liabilities Should be greater than 1
Those for inventory and receivables give anindication of liquidity.
(Current assets inventory) current liabilities Can be less than 1 if inventory turnover is fast
Current ratio
Quick/acid test ratio
Turnover periods
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Performance andshare value
Shareholders,survival and growth
Profitability Liquidity ComparisonsGearing
Calculated as:
Market value in cents or Total MV of equity__________________ _______________EPS in cents Total earnings
Reflects the markets appraisal of the shares future prospects
Assuming the P/E ratio will not vary much over time, if the EPSgoes up/down, the share price should move up/down too.
Internet companiesShort-run v long-run performance Managers have a personal interest in the long-term survival of thebusiness and shareholders want a long-term increase in their wealth frominvestment in the business. But managers performance is often measuredon short-term results and even investors are under pressure to maximisethe growth in the value of their portfolios in a particular period.
P/E ratio
Fuelled by what appeared to beunrivalled opportunities forgrowth and increasing returns toscale, share prices of internetcompanies rose dramaticallyduring 1999/2000.Despite exciting websites andhuge marketing expenditure,internet companies were madeor broken on issues of logisticsand distribution. Many wereunable to avoid the traditionalneed for profits and positive cashflow to survive.
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Shareholders,survival and growth
Profitability Performance andshare value
Liquidity ComparisonsGearing
8: Scope of strategic performance measures in the private sectorPage 83
Results of the same company over successive accounting periods
Different organisations in the same industry
They give some indication of progress but there areweaknesses in such a comparison.
The effect of inflation should not be forgotten.
The organisations progress needs to be put into thecontext of what other organisations have doneand/or special environmental/economic influences.
If they are in the same broad industry even thoughnot direct competitors, might still expect broadlysimilar performance in terms of growth.If they are direct competitors, comparisons could beparticularly useful. Which has better sales growth,or profit growth? Which has better liquidity or
working capital position?
Investors might want to know:Growth comparisonsROCE comparisonsP/E ratio and dividend yield comparisons
Between organisations in different industries
Allows comparisons at different levels to be madebetween firms and inside the firm.
Benchmarking
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Notes
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9: Divisional performance and transferpricing issues
Topic List
Divisionalisation
Setting transfer prices
Short supply of intermediate products
Negotiated transfer prices
Multinational transfer pricing
Ensure that you understand the organisational context oftransfer pricing ie why transfer prices are necessary andwhen they are set.
Then consider how prices are set. Also look at the widercontext eg taxes and EU legislation.
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Divisionalisation Negotiatedtransfer prices
Multinationaltransfer pricing
Short supply ofintermediate products
Setting transfer prices
Dysfunctional decision making (abalance has to be kept betweendecentralisation of authority to provideincentives and motivation, andretaining centralised authority toensure goal congruence)
Increase in costs of activities commonto all divisions
Loss of control by top management
It can improve the decision-making process in two ways. Quality Speed
The authority to act to improve performance shouldmotivate divisional managers.
Top management are freed from detailed involvement inday-to-day operations and can devote more time tostrategic planning.
Divisions provide valuable training grounds for future