Answers

Part 3 Examination Paper 3.3 Performance Management 1 (a) Quicklink Ltd Budgeted Profit and Loss Account for the year ending 31 May 2006 Quicklink Ltd Revenue: Contract clients: Mail Parcels Machinery/processed food Non-contract clients: Mail Parcels Machinery/processed food Celer Transport Combined

June 2005 Answers

1,769,040 1,474,200 6,747,300 9,990,540 1,651,104 1,179,360 1,124,550 3,955,014 13,945,554 1,989,000 1,921,920 3,120,000 7,030,920 6,914,634

237,600 247,500 2,700,000 3,185,100 776,160 693,000 1,469,160 4,654,260 1,615,680 1,098,240 1,990,340 4,704,260 (50,000)

2,006,640 1,721,700 9,447,300 13,175,640 2,427,264 1,872,360 1,124,550 5,424,174 18,599,814 3,604,680 3,020,160 5,110,340 11,735,180 6,864,634

Total revenue Operating costs: Fuel Salaries Sundry operating costs Total operating costs Net profit Workings (1) Sales Revenue: Quicklink Ltd Contract clients: Mail Parcels Machinery Non-contract clients: Mail Parcels Machinery Celer Transport Contract clients: Mail Parcels Processed food Total number of deliveries 468,000 234,000 35,700 Total number of deliveries 468,000 234,000 35,700

Contract deliveries (%) 60 60 90 Non-contract deliveries (%) 40 40 10

Number of contract deliveries 280,800 140,400 32,130 Number of non-contract deliveries 187,200 93,600 3,570

Fee per delivery 630 (6 x 105) 840 (10 x 105) 210 (200 x 105) Fee per delivery 882 (6 x 105 x 140%) 1260 (10 x 105 x 120%) 315 (200 x 105 x 150%) Fee per delivery 6 10

Total ()

1,769,040 1,474,200 6,747,300 Total ()

1,651,104 1,179,360 1,124,500

Total number of deliveries 132,000 (120,000 x 110%) 82,500 (75,000 x 110%) 32,500

Contract deliveries (%) 30 30 100

Number of contract deliveries 39,600 24,750 32,500

Total ()

237,600 247,500 2,700,000

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Non-contract clients: Mail Parcels (2) Fuel costs: Quicklink Ltd

Total number of deliveries 132,000 (120,000 x 110%) 82,500 (75,000 x 110%)

Non-contract deliveries (%) 70 70

Number of non-contract deliveries 92,400 57,750

Fee per delivery 840 (6 x 140%) 1200 (10 x 120%)

Total ()

776,160 693,000

Number of vehicles

Days in use

Mail and parcels Machinery

55 21

340 340

Average kilometres per vehicle per day 300 400

Cost per kilometre 010 050

Cost ()

561,000 1,428,000 1,989,000 Cost ()

Celer Transport

Number of vehicles

Days in use

Mail and parcels Processed food

22 22

340 340

Average kilometres per vehicle per day 300 300

Cost per kilometre 012 060

269,280 1,346,400 1,615,680

(3) Salaries: Quicklink Ltd Celer Transport Number of employees 70 40 Salary per annum 27,456 (26,400 x 104%) 27,456 (26,400 x 104%) Cost () 3,120,000 1,990,340 Cost () 1,921,920 1,098,240

(4) Sundry operating costs Quicklink Ltd Celer Transport (b) (3,000,000 x 104%) Per question

The businesses of Quicklink Ltd and Celer Transport are engaged in the same industry and are therefore broadly comparable. Each business has its own distinctive competence which in the case of Quicklink Ltd is the delivery of industrial machinery whilst Celer Transport has developed a specialism in the delivery of processed food. Relevant operating statistics are as follows: Quicklink Ltd 2005 Actual 105,172 357,000 93 12,764 1,700 2005 Actual Delivery mix (mail/parcels): Same day Next day On-time deliveries (%): Mail and parcels Machinery/processed food No. of lost items % of telephone calls answered within target time % of telephone calls abandoned 99% 0% 20% 80% 995% 1000% 99% 99% Quicklink Ltd 2006 Budget 110,431 374,850 93 12,764 1,700 Target Celer Transport 2005 Actual 72,679 122,727 93 8,864 1,477 2005 Actual 75% 25% 82% 97% 145 90% 200% 95% 100% Celer Transport 2006 Budget 88,830 122,727 93 9,750 1,477 Target

Revenue per vehicle (per annum) Mail and parcels Machinery/processed food Vehicle in-use % Deliveries per vehicle (per annum): Mail and parcels Machinery/processed food

The number of mail and parcel deliveries per vehicle, per annum, made by Quicklink Ltd during the year ended 31 May 2005 was 44% higher than those made by Celer Transport which explains the higher budgeted revenues per Quicklink vehicle engaged in the delivery of mail and parcels for the year ending 31 May 2006. The revenue generation per vehicle shows that the budgeted average revenue generated vehicle used in the delivery of mail and parcels in respect of the year ending 31 May 2006 amounts to 110,431 and 88,830 in respect of Quicklink Ltd and Celer Transport respectively. However, this

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difference will reduce in the year ending 31 May 2006 due to the projected growth in sales volumes of the Celer Transport business. The average mail/parcels delivery of mail/parcels per vehicle of the Quicklink Ltd part of the business is budgeted at 12,764 which is still 3091% higher than that of the Celer Transport business. As far as specialist activities are concerned, Quicklink Ltd is budgeted to generate average revenues per vehicle amounting to 374,850 whilst Celer Transport is budgeted to earn an average of 122,727 from each of the vehicles engaged in delivery of processed food. It is noticeable that all contracts with major food producers were renewed on 1 June 2005 and it would appear that there were no increases in the annual value of the contracts with major food producers. This might have been the result of a strategic decision by the management of the combined entity in order to secure the future of this part of the business which had been built up previously by the management of Celer Transport. Each vehicle owned by Quicklink Ltd and Celer Transport is in use for 340 days during each year, which based on a 365 day year would give an in use % of 93%. This appears acceptable given the need for routine maintenance and repairs due to wear and tear. During the year ended 31 May 2005 the number of on-time deliveries of mail and parcel and industrial machinery deliveries were 995% and 100% respectively. This compares with ratios of 82% and 97% in respect of mail and parcel and processed food deliveries made by Celer Transport. In this critical area it is worth noting that Quicklink Ltd achieved their higher on-time delivery target of 99% in respect of each activity whereas Celer Transport were unable to do so. Moreover, it is worth noting that Celer Transport missed their target time for delivery of food products on 975 occasions throughout the year 31 May 2005 and this might well cause a high level of customer dissatisfaction and even result in lost business. It is interesting to note that whilst the businesses operate in the same industry they have a rather different delivery mix in terms of same day/next day demands by clients. Same day deliveries only comprise 20% of the business of Quicklink Ltd whereas they comprise 75% of the business of Celer Transport. This may explain why the delivery performance of Celer Transport with regard to mail and parcel deliveries was not as good as that of Quicklink Ltd. The fact that 120 items of mail and 25 parcels were lost by the Celer Transport business is most disturbing and could prove damaging as the safe delivery of such items is the very substance of the business and would almost certainly have resulted in a loss of customer goodwill. This is an issue which must be addressed as a matter of urgency. The introduction of the call management system by Quicklink Ltd on 1 June 2004 is now proving its worth with 99% of calls answered within the target time of 20 seconds. This compares favourably with the Celer Transport business in which only 90% of a much smaller volume of calls were answered within a longer target time of 30 seconds. Future performance in this area will improve if the call management system is applied to the Celer Transport business. In particular, it is likely that the number of abandoned calls will be reduced and enhance the image of the Celer Transport business. Workings Revenue generation per vehicle: Quicklink Ltd Mail and parcels: Contract mail Contract parcels Non-contract mail Non-contract parcels Total Number of vehicles Revenue per vehicle Machinery: Contract Non-contract Total Number of vehicles Revenue per vehicle Celer Transport Mail and parcels: Contract mail Contract parcels Non-contract mail Non-contract parcels Total Number of vehicles Revenue per vehicle Processed food: Number of vehicles Revenue per vehicle 2006 1,769,040 1,474,200 1,651,104 1,179,360 6,073,704 55 110,431 6,747,300 1,124,550 7,871,850 21 374,850 2006 237,600 247,500 776,160 693,000 1,954,260 22 88,830 2,700,000 22 122,757 2005

= 105,172 (110,431/105)

= 357,000 (374,850/105) 2005

= 72,679 (88,830/110 x 90%) 2,700,000 122,757 (no change in contract values)

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Deliveries per vehicle: Quicklink Ltd 2005 2006 Actual Budget Mail and parcel deliveries: Number of deliveries Number of vehicles Deliveries per vehicle 702,000 (468,000 + 234,000) 55 12,764 35,700 21 1,700 702,000 55 12,764 35,700 21 1,700 Celer Transport 2005 2006 Actual Budget 195,000 22 8,864 32,500 22 1,477 214,500 (195,000 x 110%) 22 9,750 32,500 22 1,477

Machinery/processed food deliveries: Number of deliveries Number of vehicles Deliveries per vehicle (c)

The managing director of Quicklink Ltd might consider the acquisition of the Celer Transport business to be a good strategic move for the following reasons: The acquisition of the Celer Transport business would enable a rapid expansion of the business, whereas to grow organically in a competitive industry requires a much longer timescale and be more difficult to achieve. Since the business operates both mail/parcel deliveries there is the potential for synergies to be taken advantage of in terms of route scheduling as well as the opportunities to take advantage of the complementary mix of same day/next day business that are distinctive features of the separate businesses. The fact that each of the Quicklink Ltd and Celer Transport businesses has a distinctive competence in terms of the delivery of machinery and food products respectively helps to reduce the threat to future income streams. The combination of the Quicklink Ltd and Celer Transport business might well present opportunities to take advantage of economies of scale. There would undoubtedly be scope for savings in establishment costs, staff costs, communication costs etc. It is quite possible that the fuel costs per kilometre of the Celer Transport business during the year ending 31 May 2006, which are budgeted to be 20% higher than those of Quicklink Ltd, may reduce profitability by up to 269,280. Hence the Celer Transport business would have been budgeted to make a profit of 219,280 as opposed to a loss of 50,000 (note 1), had its fuel been provided under the terms of the contract with the supplier of fuel to Quicklink Ltd. Loss per part 1(a) Potential saving in fuel costs: Actual expenditure by Celer Transport business: 340 x 300 x 22 x (012 + 060)= Expenditure at contract rates: 340 x 300 x 22 x (010 + 050) = Potential saving in fuel costs Potential net profit (50,000)

Note (1):

1,615,680 1,346,400 269,280 219,280

NB: The above calculation assumes that the cost per kilometre of a vehicle used in the delivery of processed food would be the same as that of a vehicle used in the delivery of industrial machinery. (d) The benefits that might accrue from the successful implementation of a Total quality management programme by the management of the combined entity include the following: There will be an increased awareness of all personnel within Quicklink Ltd of the need to establish a quality culture within the company which will provide a basis of improved performance throughout the organisation. The successful adoption of a TQM philosophy would ensure that there is a real commitment to continuous improvement in all processes. It would place a greater focus on customer satisfaction since at the heart of any TQM programme is a deep-seated commitment to the satisfaction of every customer. There would be a greater emphasis upon teamwork which would be used in a number of forms e.g. quality circles which could be established with a view to improving performance within every area of the business. The fostering of team spirit will also improve communication within Quicklink Ltd. A major characteristic of a TQM programme is process-redesign which is used to simplify processes, systems, procedures and the organisation itself. In this respect the adoption of a TQM philosophy will be invaluable since the integration of the Quicklink Ltd and Celer Transport businesses will require, of necessity, a detailed review of those processes currently employed.

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The adoption of a TQM philosophy will necessitate the monitoring of quality costs in order to measure whether the objective of continuous improvement is being achieved. In this respect the aim will be to eliminate internal failure costs such as late deliveries and lost items which are clearly detrimental to a business which operates in the transport and haulage industry.

(a)

Project Year 1

Cashflow Depreciation Profit/(loss) Average invested capital Return on Investment (ROI) Cashflow Depreciation Profit Average invested capital Return on Investment (ROI)

Year 2

North 6,0000 (6,0000) nil 21,0000 nil 8,0000 (6,0000) 2,0000 15,0000 1333%

East 11,5000 (8,0000) 3,5000 20,0000 1750% 11,5000 (8,0000) 3,5000 12,0000 2917%

South 12,0000 (6,0000) 6,0000 21,0000 2857% 10,0000 (6,0000) 4,0000 15,0000 2667%

The management of the IOA Division is likely to prefer to invest in the South project as the projected return on investment is much higher than the projected returns from the North and East projects. Their choice of project would be influenced by the fact that under the terms of the management incentive plan they are eligible to receive annual bonus payments which are calculated by reference to the overall year 1 and 2 return on investment (ROI). Thus the management incentive plan is causing divisional management to adopt a short-term focus which is detrimental to the organisation as a whole. The inappropriate performance-rewards linkage can therefore be said to be precipitating dysfunctional behaviour on the part of the management of the IOA Division. It would be interesting to know for how long ROI had formed the basis of payment under the management incentive plan. We know that in recent years the IOA Division has been one of the more profitable divisions within NCL plc, however, one must question to what extent the fortunes of NCL plc have been adversely affected by the dysfunctional behaviour of not only the management of the IOA Division, but also all the other divisional management teams. On the other hand, the board of directors of NCL plc could adopt a much longer-term view and also have as an objective the maximisation of shareholders wealth. They are likely to assess the three projects on a whole-life basis and consequently will choose the project which yields the largest discounted cash flow. In this case that is the North project. Much will of course depend upon the attitude to risk of the board of NCL. The fact that the life of the East investment is only three years might well mean that there is less uncertainty in the estimate of future cashflows than there is in the estimates of the North and South projects which are forecasted to have a life of four years. (b) The use of residual income as a basis for the management incentive plan operated by NCL plc would have the following advantages: Divisional management would be more willing to accept a project with a positive residual income and this would contribute to the improved performance of NCL plc. Also, the disincentive to accept a project with a positive residual income but a return on investment regarded by divisional management as not being in their best interests would be removed, because divisional management would be rewarded. The use of annuity depreciation may improve performance appraisal by removing the effect of straight-line depreciation which tends to distort project returns especially in the early years of a projects life when invested capital remains relatively high due to the constant depreciation charge. The residual income approach using annuity depreciation will only match the NPV if the annual cashflows of a project are constant. Hence the method when applied to the North or South projects would produce an NPV which does not exactly match that previously calculated. By way of contrast it is forecast that the East project will have constant cashflows and in this instance the NPV and residual income based approach when discounted, will produce the same result. (c) The net present value of the West project is dependent upon the level of environmental expenditure that will be incurred by Division IOA at the conclusion of the project. The potential NPV of the West project can be calculated using a discount rate of 12% per annum which assumes that the West project has similar characteristics to the North, East and South projects. Net cash inflows for each of years 14 = 5 million Cumulative discount factor at 12% per annum = 3037 Therefore the present value of cashflows is 5 million x 3037 = 15,185 million and the net cash flow after the initial outlay of 12 million is 3,185,000. There is now the strategic consideration regarding whether to spend 2 million which will restore the river to its original colour and also clear 90% of the pollution caused as a result of the mining activities of the IOA Division, or to incur expenditure of a further 2 million which will completely redress any damage done to the environment by the activities of the IOA Division.

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The net present value of the potential outcomes is as follows: Environmental expenditure Net cash flow before environmental expenditure Year 4 expenditure (discounted at 12%) 2m * 0636 4m * 0636 Net present value 2 Million 000 3,185 (1,272) 1,913 (2,544) 641 4 million 000 3,185

If only 2 million of expenditure was incurred in respect of making good the local environment, the NPV of the West project would be nearly three times greater than it would be if 4 million were to be spent. However, much will depend upon the extent of that the board of directors of NCL plc is socially responsible, which in turn is dependent upon their concern for the environment in which they operate. The board of directors should acknowledge that the activities it undertakes will invariably be of concern to those communities in which it operates. With regard to the West project the board of directors of NCL plc should be mindful that the fact that the river would be polluted for up to four years constitutes a significant reputational risk because a polluted river will inevitably precipitate much negative public opinion. Moreover the board of directors of NCL plc need to be aware of the fact that whilst profits and cashflows may be reduced as a consequence of pursuing socially responsible policies their image as a socially responsible organisation will be enhanced and this may well create goodwill from which longer-term benefits may arise.

(a)

The weaknesses of traditional budgeting processes include the following: many commentators, including Hope and Fraser, contend that budgets prepared under traditional processes add little value and require far too much valuable management time which would be better spent elsewhere. too heavy a reliance on the agreed budget has an adverse impact on management behaviour which can become dysfunctional having regard to the objectives of the organisation as a whole. the use of budgeting as base for communicating corporate goals, setting objectives, continuous improvement, etc is seen as contrary to the original purpose of budgeting as a financial control mechanism. most budgets are not based on a rational causal model of resource consumption but are often the result of protracted internal bargaining processes. conformance to budget is not seen as compatible with a drive towards continuous improvement. budgeting has an insufficient external focus.

(b)

Benchmarking Benchmarks enable goals to be set that may be based on either external measures of best practice organisations or internal cross-functional comparisons which exhibit best practice. A primary aim of the traditional budgeting process is the setting of realistic targets that can be achieved within the budget period. The setting of realistic targets means that the extent of underperformance against best practice standards loses visibility, and thus short-term financial targets remain the predominant focus of the traditional budgeting process. It is arguable that because the budgetary reporting system purports to give managers control, there is very little real incentive to seek out benchmarks which may be used to raise budgeted performance targets. Much depends upon the prevailing organisational culture since benchmarking may be viewed as an attempt by top management to impose impossible targets upon operational managers. The situation is further exacerbated where organisations do not measure their success relative to their competition. Balanced scorecard The Balanced scorecard is often misunderstood as a consequence of the failure by top management to ensure that it is implemented effectively within the organisation. Thus it may be viewed as the addition of a few non-financial measures to the conventional budget. In an attempt to overcome this misperception many management teams now establish a performance-rewards linkage based upon the achievement of Scorecard targets for the forthcoming budget period. Unfortunately this can precipitate dysfunctional behaviour at every level within the organisation. Even in situations where the Scorecard has been well-designed and well-implemented it is difficult for it to gain widespread acceptance. This is because all too often there exists a culture which places a very high value upon the achievement of the fixed annual targets in order to avoid the loss of status, recognition and rewards. A well-constructed Scorecard contains a mix of long-term and short-term measures and therefore drives the company in the direction of medium-term strategic goals which are supported by cross-functional initiatives. On the other hand, the budgeting process focuses the organisation on the achievement of short-term financial goals supported by the initiatives of individual departments. Budgets can also act as an impediment to the acceptance of responsibility by local managers for the achievement of the Scorecard targets. This is often the case in situations where a continued emphasis exists on meeting shortterm e.g. quarterly targets. Activity-based models Traditional budgets show the costs of functions and departments (e.g. staff costs and establishment costs) instead of the costs of those activities that are performed by people (e.g. receipt of goods inwards, processing and dispatch of orders etc). Thus

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managers have no visibility of the real cost drivers of their business. In addition, it is probable that a traditional budget contains a significant amount of non-value-added costs that are not visible to the managers. The annual budget also tends to fix capacity for the forthcoming budget period thereby undermining the potential of Activity-based management (ABM) analysis to determine required capacity from a customer demand perspective. Those experienced in the use of ABM techniques are used to dealing with such problems, however their tasks would be much easier to perform and their results made more reliable if these problems were removed.

(a)

Dental Health Partnership Summary Profit and Loss Account for the year ended 31 May 2005 Fees received 1,226,880 (Note 1) Other Operating Income 20,800 Total Income 1,247,680 Less: variable costs Material and consumables 446,400 Less: fixed costs Salaries 538,880 Establishment costs 85,000 Other operating costs 75,775 Total costs 1,146,055 Net profit for the period 101,625 Calculation of % of total capacity required to break-even during the year ended 31 May 2005. Fees received Less: variable costs Contribution Total number of consultations Weighted average contribution per patient visit Total fixed costs: Salaries Establishment costs Other operating costs Less: fixed income Total fixed costs less fixed income Divide by weighted average contribution per patient visit Total capacity for patient visits= 1,226,880 446,400 780,480 28,800 = 780,480/28,800 = 2710 538,880 85,000 75,775 699,655 20,800 678,855 678,855/2710 = 25,050 consultations. 28,800/08333 = 34,560 per annum

Therefore percentage of maximum capacity required in order to break-even is 25,050/34,560 = 725% Note 1. Fees received: Adult fees = Payment plus Government refund Children/Senior Citizens = Government refund Adjusted patient mix is as follows: Adults Children Senior Citizens Total 50% x 2 = 100% 40% 10% 150% 840 1000 1000 2840

The weighted average fee per patient is as follows: Type of patient treatment: None 070 x 12 = Minor 020 x 50 = Major 010 x 100 = Total

Therefore fees received during the year ended 31 May 2005 = 28,800 x 15 x 2840 = 1,226,880.

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Note 2. Capacity: Each dentist had a maximum of 24 patients per day but on average treated 20 patients per day which equates to 83333% of maximum capacity. (b) The major characteristics of services which distinguish services from manufacturing are as follows: Intangibility. When a dentist provides a service to a client there are many intangible factors involved such as for example the appearance of the surgery, the personality of the dentist, the manner and efficiency of the dental assistant. The output of the service is performance by the dentist as opposed to tangible goods. Simultaneity. The service provided by the dentist to the patient is created by the dentist at the same time as the patient consumed it thus preventing any advance verification of quality. Heterogeneity. Many service organisations face the problem of achieving consistency in the quality of its output. Whilst each of the dentists within the Dental Health Partnership will have similar professional qualifications there will be differences in the manner they provide services to clients. Perishability. Many services are perishable. The services of a dentist are purchased only for the duration of an appointment. (c) In order to assess the quality of patient care provided by the Dental Health Partnership the following performance measures might be used: The percentage of on time treatment of those patients who arrived prior to their appointment time would provide an indication regarding the effectiveness of the scheduling of appointments by the Dental Health Partnership. the percentage of patient appointments which were re-arranged at the request of the Dental Health Partnership. Rearranged appointments represent the provision of a lower level of service provision to clients who may, as a result, switch to an alternative dental practice. the percentage of patients who return for treatment after their first appointment would provide an indication that they were satisfied with the service they received. the percentage of patients who were able to gain an appointment at their preferred date and time is an indication of the availability of the service to clients.

Note: Candidates were only required to discuss three measures.

(a)

The overall performance of Taliesin Ltd during the year ended 31 May 2005 can be measured by its Return on Capital Employed (ROCE) as follows: Profit Before Interest Total Assets less Current Liabilities = = 2005 5,000 66,000 758% 2004 4,000 52,000 769%

A figure of 758% is not good especially when Taliesin Ltd has borrowed money at 10% in order to develop further. 758% is a slight fall from 2004. Since this information was available at the start of the 2005 financial year the directors should have reconsidered their objective of growth. Sales have increased by 20% over the previous year. There is a considerable variation in the sales achieved by Taliesin Ltd in the different halves of their accounting year. This variation in seasonal demand required the hiring of a secondary core work force for the period 1 June 30 November during each financial year. Most of the growth in sales revenue occurred during the first half of the year ended 31 May 2005. Cost of sales has remained constant at 60% of sales. It is interesting to note that the composition of cost of sales has changed during the year and management attention should be focussed on this in order to ascertain the reasons for this change. The material percentage content of cost of sales has remained constant whereas labour has decreased. Manufacturing overheads comprise the majority of cost of sales in 2005 (515%). This is an increase of 15% over 2004. 2005 % of cost of sales: 325 160 515 1000 2004 % of cost of sales: 325 175 500 1000

Materials Labour Overheads

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Whilst the gross profit percentage has remained constant at 40% the net profit percentage has reduced from 10% to 833%. In absolute terms, Taliesin Ltd has earned the same profit during the year ended 31 May 2005 as it did in the previous year. Operating costs have risen by 275% over the previous years level. The company has also paid 1 million in interest on a loan which was taken out during the year presumably to finance the plant and equipment required in order to manufacture the six new products. Details of the composition of net current assets are required in order to ascertain the liquidity position of Taliesin plc and thereby gain a fuller picture of the financial position of Taliesin Ltd. From the information provided it would appear that although sales increased by 20% over the previous years level, Taliesin Ltd has lost a customer during the year ended 31 May 2005. It is quite conceivable that this only happened towards the end of the year and thus the profit and loss account might not fully reflect financial consequences of the lost customer. The loss of the customer could well be highly significant since the company had only six customers at the start of the year. It is highly probable, therefore, that each of the six customers, being supermarkets, purchased in relatively large volumes and thus significant turnover may have been lost. This will only become apparent during the next year but Taliesin Ltd should attempt to find a new customer to replace the lost customer as soon as possible. Growth may only have been achieved by introducing new products. There may be a limit to the number of times that this can be done effectively. It has already been noted that the six new products have led to a loan, the cost of which exceeds the return generated by Taliesin Ltd. (b) The major benefits of pursuing a policy of internal development that may accrue to Taliesin Ltd are as follows: By confining their activities to its internal environment the company avoids the need to manage the integration of businesses which is necessitated by an acquisition. Management teams, when considering the acquisition of another organisation, very often underestimate the costs of integration. There is no need for the board of directors of Taliesin Ltd to familiarise itself with different organisational and national cultures, values etc, thereby avoiding many potential problems. The board of directors of Taliesin Ltd is better able to control the activities of the business and the need for more complex supply chains and strategic alliances with foreign organisations is rendered unnecessary. All investments are made at market price whereas if the board of directors was to attempt to grow the business acquisition then significant outlays would probably be made in respect of purchased goodwill. As the organisation develops and expands, staff are provided with development and learning activities that may precipitate an increase in the level of their commitment to the organisation.

(c)

The usefulness of activity-based techniques is accentuated in situations where overheads comprise a significant proportion of product costs. Manufacturing overheads comprise 309% of turnover during the year ended 31 May 2005. Traditional methods of allocating overheads to products might result in product cost information which is misleading and detrimental to managerial decision-making. Calculations of product costs are more prone to error in situations where higher levels of overhead exist. The consequences can prove disastrous as, for example, in the under-pricing or over-pricing of products. Since Taliesin Ltd is going to confine its activities to its home country it must be prepared to face increased competition and this increases the need for greater visibility and more accurate product cost information. At present, Taliesin Ltd offers a range of products which is increasing in number and this may lead to the need for a more detailed costing system. Traditional absorption systems might well be inadequate as the number of product variants increases. One would expect that each new product developed is more complex than its predecessors. The company would probably start with simple Vanilla, then a few basic flavours but as Taliesin Ltd has expanded one would expect it to take longer to originate and test new products until they are ready to be introduced. It will probably take longer to mix the ingredients for a run of each product. These two, development and mixing ingredients, are examples of activities which arise when new products are considered. If traditional absorption costing and budgeting are used based on machine-time in production then the effect of these activities would be ignored. In order to gain a full appreciation of the impact of new product introduction activity-based techniques should be used to guide Taliesin Ltd into the easiest way to maintain its policy of growth. It may be a better decision to expand abroad or into new markets at home with the existing products than pursue growth by introducing new products to a dwindling number of customers. We are not told of the composition of the customer base of Taliesin Ltd. However, one thing we do know is that the scope of activity-based techniques extends beyond products and services. For example, the application of activity-based costing can provide vital information that enables management to undertake customer profitability analysis, thereby further improving management decision-making and operating performance.

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Part 3 Examination Paper 3.3 Performance Management Marks 11 4 1 1 2 8 65 6

June 2005 Marking Scheme Marks

(a)

Sales revenue Fuel Salaries Sundry operating costs Presentation (including profit/loss) Revenue generation per vehicle Vehicle utilisation and delivery mix Service quality Comments (on merit) four required Link to: Improved performance Continuous improvement Customer satisfaction Team spirit Process-redesign Quality costs Other relevant comments Total

Maximum 16

(b)

Maximum 14 Maximum 5

(c) (d)

up to 15 marks each 1 1 1 1 1 1 2

Maximum 5 40

(a)

Relevant calculations Comments (on merit) Comments (on merit) Residual income Annuity depreciation Revenue Expenditure Net cash flow Comments (on merit) Total

6 4

10

(b)

2 3 1 1 1 3

Maximum 4

(c)

6 20

(a)

Comments (on merit): Inherent disadvantages (five required) Benchmarking Balanced scorecard Activity-based models Total

Up to 2 marks each 4 4 4

Maximum 8

(b)

12 20

29

(a)

Fee income Materials and consumables Salaries Establishment and other operating costs Other operating income/profit Calculation of break even capacity utilisation Comments (on merit): Intangibility Simultaneity Heterogeneity Perishability

Marks 4 05 1 05 1 5

Marks

12

(b)

Up to 15 each

(c) One mark per performance measure Total 3

Maximum 5 3 20

(a)

Comments (on merit): Return on Capital Employed (ROCE) Sales revenue Cost of sales Operating costs Interest payable Net profit New product introduction Lost customer Net current assets Other relevant comments Comments (on merit): Avoidance of problems re: Integration of different businesses Different cultures Control Purchased goodwill Other relevant comments Comments (on merit): High overhead content More accurate product cost information Extension to customer profitability analysis Other relevant comments Total

2 2 2 1 1 1 1 2 1 2

Maximum 11

(b)

Maximum 4

(c)

Maximum 5 20

30