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PERFORMANCE MANAGEMENT
The learning curve has serious cost ramications for manufacturers. Aaron Toogood gives his guide to the most examinable calculations.
Imagine that youve just moved to a new city for a new job. Its likely that youd leave a little early for work on your first morning, as you may not be familiar with the exact length of your new commute. Through observation, repetition and discussion with your new colleagues, youd eventually find the route that minimises the time you spend travelling. Your initial time savings may be significant, as you determine the most convenient exit from the railway station, say, or find an alleyway that provides a short cut. Later savings are likely to be smaller as you refine your route. The table below gives possible times for the first eight trips to the new workplace from the railway station and the times saved on the preceding journeys. If we analyse the sequence mathematically it becomes clear that the amount of time saved is decreasing and we can assume that it will not become negative (which would imply that the journey is getting longer), so at some point we must approach a time saved of zero minutes. This equates to journey refinements continuing to a point where the benefit increments are insignificant. The route at this point is optimal, meaning that there isnt a quicker option. The benefits of repeating the trip come from having learned more efficient ways to achieve the same result or reach the same destination. This type of mathematical sequence of decreasing increments has been observed in many contexts. In the 18th century Adam Smith, the father of modern economics, Sample times for first eight journeys Journey number 1 2 3 4 5 6 7 8 Time taken (minutes) 20.0 16.0 14.8 14.0 13.5 13.1 12.8 12.5 Time saved (minutes) 4.0 1.2 0.8 0.5 0.4 0.3 0.3

presented the law of diminishing returns to describe the decreasing growth in output yielded by adding extra units of input. This law can also be used to describe patterns found in such diverse activities as the number of errors played in a piece of music as its practised to the amount of grass clippings resulting from the repeated cutting of a lawn. In 1936 a US aeronautical engineer called Theodore Paul Wright observed that, as aircraft production workers repeated a task, the time they took to complete it reduced, thereby increasing the productivity or output per unit of labour, and that this decrease in time (or increase in productivity) reduced at each iteration. This relationship became known as the learning curve. The implications of the learning curve for relevant costing are profound, since the time taken by the first attempt to perform an activity is likely to exceed the time that the activity would take after repeated practice. As such, the cost estimate for the process in question may be too high. This could lead to lost bids or even high favourable operational variances (owing to the setting of insufficiently high output standards). Its essential, therefore, for management accountants to understand this learning effect.

For a learning curve to be observed, the following factors are required: Consistency in the workforce ie, the same people keep performing the task. Consistency in production eg, there are no lengthy periods of downtime that might allow people to get out of practice. A repetitive task. A task with a significant manual element. A motivated workforce. A product at an early stage of its life cycle. The following mnemonic phrase may help you to recall all these factors in the exam: If consistently asked to do manual, repetitive tasks, workers will lose motivation early. To understand this type of relationship, lets examine journey efficiency using the dependent variable of repetitions (X) and the average time taken as the independent variable (Y). The nature of this relationship is not linear ie, a particular change in the dependent variable will not cause the same change in the independent variable but exponential. As such, the relationship must be of the following form: Y = AXB, where A is the length of time taken to complete the first journey and X is the number of journeys in question. B (always a negative figure) is the learning index, which indicates how quickly

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nancial management

PAPER P2

the journey time will fall. It can be expressed as: B = log(R) log(2). R is the rate of learning. To illustrate what this describes, and to show the significance of the log(2) figure, lets return to the original journey time, assume that R is 90 per cent and work out what the average time of one journey would be after eight trips as follows: Y = 20 x 8[log(0.9) log(2)] = 14.58 minutes. Note that this figure represents the average time of the first eight journeys, not the time taken for the eighth journey. If we do the calculation for four journeys, the significance of both the log(2) figure and R becomes clear: Y = 20 x 4[log(0.9) log(2)] = 16.20 minutes. If we divide the average time after eight trips by the average time after four trips we get: 14.58 16.20 = 90 per cent. From this we can deduce that, as the total output doubles hence the 2 in the log(2) part of the equation the average time taken across all units of output drops to the rate of learning of the previous level. Putting it another way, doubling the output will decrease the average time to 90 per cent (or whatever the value of R thats given) of its current level. The P2 syllabus requires you to understand what R represents, which means that it could specifically be examined. Although finding the average journey time is of some use, calculating the following three pieces of information may prove more useful to a management accountant (and may become the basis for exam questions): Calculation type 1: the total time taken to travel X journeys eg, the first eight journeys in total. In order to convert the average time for a journey to the total time taken, we simply multiply that average by the number of trips. Using the previous example, the total time for four journeys is 16.20 x 4 = 64.80 minutes. And the total time for eight journeys is 14.58 x 8 = 116.64 minutes. Calculation type 2: the time taken to travel the Xth journey eg, the eighth journey alone. To work this out, we simply subtract the total time taken for the first

Deconstructing the question

20 19 Journey time (minutes) 18 17 16 15 Steady state 14 13 12 11 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 Number of journeys Calculation type 1 Calculation types 1 and 2

seven journeys from the total time taken for the first eight. In this case its: 116.64 ({20 x 7[log(0.9) log(2)]} x 7) = 12.49 minutes. Calculation type 3: the total time taken to travel the Nth to Xth units eg, the fifth to eighth journeys. To obtain this, we subtract the total for the first four trips from the total for all eight as follows: 116.64 64.80 = 51.58 minutes. One final complication is the presence of the steady state in this case, the number of journeys beyond which no further time savings are gained. There are two main reasons why this may occur: the workers are at their physical limits (or, in this case, you cannot walk any faster); and/or the machinery is at its limit, preventing workers from increasing their output (or, in this case, there are no other roads available that could cut the distance you have to walk). If a steady state is achieved after 15 trips, it means that all subsequent journeys take the same time as the 15th. This can complicate calculations for questions where the last journey occurs after the steady state has been achieved for instance, what is the total time taken for the first 20 journeys? Before working out the answer, its worth illustrating this question graphically. The graph above breaks the question into two

parts: the time taken for the first 15 journeys plus the time for journeys 16 to 20. To work out the total time taken by the first 15 journeys, we can use calculation type 1: {20 x 15[log(0.9) log(2)]} x 15 = 198.77 minutes. Moving on to journeys 16 to 20, we know that each trip after the steady state has occurred takes the same amount of time as the last journey before that state exists in this case, the 15th trip. So the total time for journeys 16 to 20 equates to the time taken by the 15th trip multiplied by five. Working out the time for the 15th journey calls for a type 2 calculation ie, subtracting the total time for 14 journeys from the total time for 15 journeys, which weve just found: 198.77 ({20 x 14[log(0.9) log(2)]} x 14) = 11.30 minutes. Multiplying that result by five gives us: 11.30 x 5 = 56.50 minutes for the total time for journeys 16 to 20. So the total time for the first 20 journeys is: 198.77 + 56.50 = 255.25 minutes. A question and model answer relating to this article will be published in the December issue of CIMAs student e-magazine Velocity (www.cimaglobal.com/velocity). Aaron Toogood is senior lecturer in finance and CIMA course manager at De Montfort University, Leicester.

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