ACCA

Paper P5
Advanced Performance
Management

Final Mock Examination

Commentary, Marking scheme and

Suggested solutions

ACP5FM08(J)
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Commentary
Tutor guidance on improving performance on the exam paper
The key to success in P5 is application of wide and varied syllabus knowledge, both flexibly and in enough depth
in the time allowed. This mock examination is a realistic test of your ability towards the final stages of your
preparation for the real event.

Section A

Q1 Crown Oak Construction (COC)

Part (a) of this question provides a budgeted and actual income statement for a quoted company together
with selected balance sheet information and the actual figures for an unquoted competitor (HC). Using a
variety of ratios you are then required to compare the performance of COC against budgeted and HC
and prove certain numbers in the statements from operating data provided.
In part (b) you are then provided further information about the strategies of COC and HC and are then
required to determine how these stated strategies help assess performance. Part (c) requires a
discussion of the problem of short-run results and long-run results and finally part (d) requires you to
consider the likely reaction of shareholders to the results that you have been working on.

Q2 Jolene Communications (JC)

Part (a) is a factual definition of what is meant by the planning gap. In part (b) two possible pricing
strategies are given for a new product and you are required to assess the remaining profit gap under
each of the two strategies. Finally in part (c) you are to use Ansoff’s product matrix model to consider any
other strategies that could be followed.

Section B

Q3 Glenn Associates (GA)

This question considers non-financial performance indicators. In part (a) you are to consider why there is
growing emphasis on NFPIs for service businesses such as GA. You are also provided with a data which
you must use in part (b) to create NFPI’s. Explanation of usefulness must relate to the critical success
factors and strategies of GA.

Q4 Edwards Incorporated (EI)

This question concerns decision making in divisions and the opportunity for dysfunctional behaviour. Part
(a) requires some simple calculations to illustrate the problems of ROI and RI and EVA. Part (b) requires
four reasons to separate the assessment of a divisional manager from assessment of the division itself.
Part (c) considers the problems of comparing the performance of divisions in different countries and
requires little application to GA to score well.

3
Q5 Management accounting and reporting
This essay covers how contingent factors affect management accounting systems, open and closed
systems and the principal controls over the preparation and distribution of internal information. It is vital to
answer the question set and not to wander from the requirements by repeating what you have learnt on
these topics.

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SECTION A

1 Crown Oak Construction

Marking scheme
Marks
(a) 3 professional marks for presentation etc 3
1 mark for each proof of budgeted and actual figures 4
Calculation and discussion of ratios Max 15
Max 20
(b) COC 4
HC 4
8
(c) General comments regarding short v long term 4
Application to COC 4
8
(d) Importance of information available 1
Importance of dividend signal 2
Belief in long term growth 1
4
40

Suggested solution
(a) REPORT
To: Chief accountant
From: Accountant
Date: June 2008
Subject: Performance of COC and HC
Introduction
The information in this report has been based upon the summarised budgeted and actual income
statements of COC for the year ended 31 March 2008 together with some additional information
and the same information provided for our direct competitor HC.
Revenue and profitability
COC’s revenue is slightly less (2.8%) less than budget but 25% less than HC despite the fact that
HC has a smaller capital base. The budgeted gross profit margin for COC was similar to that of
HC but the actual gross profit margin of COC is considerably lower, indicating significantly higher
direct costs. The position is even worse when the operating profit margin is considered which is
only 7.7% compared to 19.5% for HC.
If the costs are examined by category depreciation is much higher than was either budgeted for or
charged by HC. This, together with the increased loan capital, indicates that there has been
considerable investment by COC in additional non-current assets during the year. The staff costs
are exactly as budgeted, which would indicate that these are fixed costs of support staff.
General expenses to sales are not only higher than budgeted but also a greater percentage of
sales than charged by HC indicating that COC may have a problem with the control of its other
expenses. However, the main reason for the large fall in operating profitability below budget and
below that achieved by HC is the large amount of costs incurred in sub-contracting work. This is
over 50% more than the amount that was budgeted for and considerably higher as a percentage
of sales than those sub-contracting costs incurred by HC.

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This reduction in profitability is a large part of the cause of a return on capital employed of only
6.4% compared to a budgeted figure of 16.5% and the return achieved by HC of 23.0%. However
the other reason for the low level of return on capital employed is that the asset turnover, is lower
than the budgeted figure and both the budgeted and actual asset turnovers are much lower than
that of HC. This indicates that HC is using its capital more intensively and effectively than COC.
However, part of the reason for the lower asset turnover is that investments in new non-current
assets in COC may not have been fully utilised for the whole of the accounting period.
Finally in terms of profitability there is a worrying concern about the number of employees in COC.
The budgeted figure was for 2,000 employees which would have resulted in a budgeted profit per
employee of $28,500. However as there has been a large reduction in profitability in COC as well
as a 20% increase in employees above those budgeted for then the profitability per employee has
fallen to a miserable $6,667 compared to $31,200 achieved by HC. If this is a long term trend for
COC then there must be serious concerns about the management of the business.
Other financial indicators
The gearing level of COC has increased from 18.7% to 29.1% as an additional $40 million of loan
capital has been taken out reducing the interest cover from 10.4 times as budgeted to 3.1 times. It
is a concern that something as important as additional loan capital at this level had not been
budgeted for. However it should be noted that either the interest rate for the new loans is lower
than the budgeted amount of 10% per annum of that the loans were only taken out part way
through the year. By comparison HC has almost insignificant gearing (20/444 = 4.5%), which may
indicate the difficulties of raising finance for an unquoted company or the lack of desire for debt by
the business.
The dividend of $30 million is as budgeted despite profits of only $16 million. This dividend was
partly paid out of previously retained profits. In a quoted company dividends are considered to be
very significant and a reduction over what is expected may have a detrimental effect on share
price. This is why the dividend was maintained at prior period levels despite the lack of profits to
support it. The policy of HC, however, is clearly very different as with a much higher profit level of
$78 million after tax only $15 million was paid out as dividend with the remainder retained in the
company. As an unquoted company, HC may have other reasons for making not making
distributions: the objectives of shareholders, the lack of debt capacity or possibly the tax position
of directors or shareholders.
Conclusion
From the information available there should be some concern about the financial and operating
performance and management of COC. Although budgeted gross profit margin is similar to that of
HC, thereby indicating a similar performance level, all other budgeted figures are lower, which
means that the management of COC has lower expectations of their effective and efficient use of
the resources available to them. The actual results of COC are considerably worse than
budgeted.

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Appendix – proof of budgeted and actual revenue and cost of sales
Budgeted revenue
Budgeted volume Price Revenue
Units $ $m
Barns (41,000 x 17%) 6,970 18,000 125.46
Garages (41,000 x 41%) 16,810 12,000 201.72
Car ports (41,000 x 26%) 10,660 8,000 85.28
Other (41,000 x 16%) 6,560 6,000 39.36
451.82

Actual revenue
Actual volume Price Revenue
Units $ $m
Barns (6,970 x 78%) 5,437 18,000 97.87
Garages (16,810 x 1.08) 18,155 12,000 217.86
Car ports (10,660 x 1.05) 11,193 8,000 89.54
Other (6,560 x 85%) 5,576 6,000 33.46
438.73

Budgeted cost of sales

Budgeted Materials Labour Cost
units cost cost of sales
$m $m $m
Barns 6,970 46.42 30.11 76.53
Garages 16,810 78.67 42.36 121.03
Car ports 10,660 26.44 23.03 49.47
Other 6,560 14.96 10.04 25.00
272.03

Actual cost of sales

Actual Materials Labour Cost
units cost cost of sales
$m $m $m
Barns 5,437 36.21 26.10 62.31
Garages 18,155 84.97 50.83 135.80
Car ports 11,193 27.76 26.86 54.62
Other 5,576 12.71 9.48 22.19
274.92

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Workings – financial performance indicators
Note: Not all these figures are required to answer this question. A selection of suitable ratios
should be included in the answer. A full schedule of ratios is included here for completeness.
COC COC HC
Budget Actual
Gross profit margin
180/452 x 100 39.8%
164/439 x 100 37.4%
219/550 x 100 39.8%

Operating profit margin

83/452 x 100 18.3%
34/439 x 100 7.7%
107/550 x 100 19.5%

General expenses : sales

22/452 x 100 4.9%
28/439 x 100 6.4%
23/550 x 100 4.2%

Subcontractor costs : sales

34/452 x 100 7.5%
52/439 x 100 11.8%
39/550 x 100 7.1%

Return on capital employed

83/(424 + 80) 16.5%
34/(413 + 120) 6.4%
107/(444 + 20) 23.0%

Asset turnover
452/(424 + 80) 0.90
439/(413 + 120) 0.82
550/(444 + 20) 1.19

Profit per employee

$57m/2,000 $28,500
$16m/2,400 $6,667
$78m/2,500 $31,200

Interest cover
83/8 10.4
34/11 3.1
107/2 53.5

Dividend cover
57/30 1.9
16/30 0.5
78/15 5.2

Earnings per share

$57/200 28.5 c
$16/200 8.0 c
$78/250 31.2 c

Gearing (Loans/Shareholders’ Funds)

80/424 18.7%
120/413 29.1%
20/444 4.5%

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(b) Crown Oak Construction
COC has changed its strategic direction, moving into a different product, building houses from
pre-assembled imported parts. This product development will help to explain the performance of
COC.
Revenue of this new product line should be included in other revenue. Revenue here is below
budget, which indicates that this new line may be taking time to gain market acceptance and that
other product sales are also deviating significantly from budget. If sales are suffering from
recession this could indicate that COC is wise to look for cheaper product lines.
For this new line of business there has been significant investment in new non-current assets
which will explain the increased gearing level and the increased depreciation charge over the
amount budgeted. However, unless this was a very late decision on the part of the management
of COC, one would have expected these figures to have been included within the budget,
particularly the additional loan capital. It is possible that this strategy emerged during the year
when results were seen to be diverting from budget.
The pre-assembled parts for the houses are imported from Sweden which may partially account
for the increased direct costs and lower gross profit margin. This new line of business may also
have required additional employees which were not envisaged when the budget was set.
A worrying feature of COC’s income statement is the large amount of sub-contractors costs which
were very much higher than those budgeted for. It is entirely possible that the management of
COC underestimated the amount of additional work that the house assembly would require and
this has resulted in the increased number of employees and increased sub-contracting costs.
There is probably a large learning curve for the company in carrying out such new work.
Finally, the lower average rate of interest this indicates that the loans and capital investment took
place part way through the year and therefore this new line of business may not have been fully
operational for the entire year. This will have affected profits which may well revert to more
healthy figures once the business is fully established and COC has more experience in this area.
If COC can control its costs in the way that HC clearly does and works through the learning curve
of its new line of business then it is possible that results may improve in future periods.
Henderson Construction
HC has a completely different strategy to COC which centres upon increasing profitability by
constant monitoring of costs in the current line of business but no growth by new market or new
product development. Pressure to remove non-value added costs and activities will be a key part
of this strategy and would appear to be the reason why all levels of costs for HC are lower than
those budgeted for COC and profit levels higher. HC’s shareholders may be risk averse,
especially if they are also the directors of the business and may be more focussed on internal
control than on strategic planning initiatives.
HC also has a lower asset base than COC. This accounts, in part, for improved ROCE figures.
One way to reduce costs, including depreciation, and harvest stronger results from business is to
maintain older assets which are held at lower net book values. If this is the case, then HC’s higher
ROCE and earnings may not be maintained indefinitely as assets reach the end of their useful
lives and have to be replaced.
(c) It could be argued that in general terms the directors of a company have a short-term interest in
their company, in terms of their employment and remuneration, whereas the equity investors have
a longer-term interest as they have made an investment in the shares in order to secure a return
over time. It can also be argued that the directors of a company need to produce results in the
short-term in order satisfy the requirements of the investors in terms of earnings per share each
year At only 8.0 cents per share for COC compared to a budgeted figure of 27 cents the COC
shareholders may well have reasons to be concerned over short-term performance. The level of
dividend has only been maintained by payment form retained profits of prior years. However as
COC is quoted, shareholders always have the opportunity to liquidate their investment if they are
not happy with the returns they are receiving from their investment, although the price they realise
for the shares may well have fallen from previous levels.

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 Therefore there is likely to have been much debate at COC over the investment in the new house
assembly business. The budgeted figures for COC show that, although it does not attempt to
control costs as strictly as HC, the expectations of management were that profitability would not
be too far behind that of HC. This should have satisfied shareholders in the short-term and the
directors themselves who would have continued to be run a profitable and stable company.
However the decision was taken to turn to a relatively new product with initial capital costs and
other learning factors. Inevitably this has led to depressed short-term results although the
directors firmly believe that the long term prospects are good especially given the likely future
economic conditions. Therefore the decision to invest for the longer term growth of the company
rather than short-term continuation of profits was a brave one.
(d) The likely reaction of the shareholders in COC will depend upon the amount of information that is
available to them. Clearly there has been a downturn in results and their earnings per share is
lower than budgeted and probably than previous years. It is also considerably lower than that of a
direct competitor in the form of HC.
However the directors of COC have taken the decision to keep the dividend in total and dividend
per share at the same amount as that which was budgeted despite the reduced profitability. This
should indicate to the shareholders that the directors of COC have confidence in the long term
future of the company despite the short-term downturn in results.
It is often advisable for the chief executive of a company to meet with key shareholders,
particularly institutional shareholders on a regular basis, in order to keep them informed of major
developments such as this move into a new line of business.
If the shareholders are informed of what is going on in COC and believe the directors assertions
of future levels of profitability, backed up by the dividend payment, then there should be little effect
on the share price of COC. However if the shareholders are not informed or do not believe in the
return to profitability levels then these results may lead to a fall in the share price of COC.

10
2 Jolene Communications
Marking scheme
Marks
(a) Correct definition / explanatory diagram 2
Why concerned 2
4
(b) Required profit 1
Marginal cost price 1
Marginal cost profit gap 1
Use of demand function for price and quantity 5
Optimal price profit gap 2
10
(c) Definition of matrix 1
1 mark for each strategy as applied to JC ( max 5 strategies) 5
Combinations to fill gap 1
max 6
20

Suggested solution
(a) The performance planning gap is the difference between the forecast position according to the
expected performance from the current activities of the organisation and the desired forecast
position from the perspective of the strategic planners. Therefore this performance planning gap
can be determined by comparing the strategic target for the forecast period (be it revenue, market
share, profit etc) and the forecast performance if the company continues with its current
strategies. If the current strategies are not sufficient to meet the desired strategic position then
new strategies must be developed to close the planning gap.
As part of their strategic planning process, the Board of Directors of JC have set an objective of
increasing profits by 10% per annum for the next three years. The Mobsat is a key part of this
strategy to achieve the objective of this increase in sales. If the performance planning gap
analysis indicates that the profits from the Mobsat will not meet this objective then decisions will
need to be made to reduce the costs of the Mobsat, to increase its selling price or to a follow a
different pricing policy in order to ensure that the overall objective of this increase in profits is
achieved. Failing this, new strategies may need to be implemented.
(b) Required profit level by 31 March 2011 = $100 million x 1.10 x 1.10 x 1.10
= $133.1 million
If Mobstat priced using strategy of marginal cost plus pricing
$m $m
Current profits ($100 x 1.02 x 1.02 x 1.02) 106.12
Sales of Mobsat (500,000 x $160) 80.00
Less: variable cost (500,000 x $100) (50.00)
Contribution 30.00
Less: fixed costs (20.00)
Forecast profit 116.12

Planning gap ($133.1 – 116.12) $16.98 m

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 If Mobstat priced using strategy of optimal pricing
Optimal price for Mobsat
Use demand function where P = a – bq
P = selling price at which q units can be sold
a = price at which zero units are sold
b = change in unit price/change in quantity demanded
q = quantity demanded
b = $10/20,000 = 0.0005

$200 = a – (0.0005 x 400,000)

$200 = a - $200
a = $400
So, demand function P = 400 – 0.0005q
Total revenue function Pq = 400q – 0.0005q2
Marginal revenue function = 400 – 0.001q
To maximise profits, the optimal quantity to sell can be established by setting marginal revenue
equal to marginal cost
400 – 0.001q = 100
0.001q = 400 – 100
0.001q = 300
q = 300,000
Therefore optimal quantity to be sold to maximise profit is 300,000 units
At this quantity P = 400 – (0.0005 x 300,000)
P = $400 - $150
P = $250
$m $m
Current profits ($100 x 1.02 x 1.02 x 1.02) 106.12
Sales of Mobsat (300,000 x $250) 75.00
Less: variable cost (300,000 x $100) (30.00)
Contribution 45.00
Less: fixed costs (20.00)
Forecast profit 131.12

Planning gap ($133.1 – 131.12) $1.98m

(c) Ansoff’s product matrix model considers the various combinations of products and markets to
determine strategies that may be available to an organisation that is seeking growth. This gives
four combinations which may lead to new strategies for the business.
Current product and current market
This includes strategy of market penetration where the organisation seeks to increase its share of
the current markets with the current products. JC currently operates in in-car satellite navigation
systems and would look to gaining share by competitive pricing or advertising and promotions.
Profits might also be increased by withdrawing from areas (products in particular) that are in
decline as they near the end of the life cycle. JC’s products are not likely to have extended
lifetimes as they are quickly superseded by new technologies.

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Current product and new market
This is a strategy of market development which could be moving into new geographical markets
such as the export market or finding new distribution channels in order to attract new customers.
JC could approach retailers that it not currently using, or could look to using the internet as a sales
channel.
New product and current market
This is a strategy of product development which is the one that JC has currently chosen with the
development of the Mobsat. There may be more new products in the research and development
pipeline which JC could develop.
New product and new market
This is a strategy of diversification which could lead to growth provided that the products and
markets chosen offer better prospects for growth than the current product/market combination.
Related diversification concerns activities that are complementary to the current business, which
for JC could include retailing or manufacture of components that it currently buys from third
parties. Unrelated diversification involves moving into products or markets with no known
connection to the current business, so will increase risk. This type of strategy usually requires
acquisition of another business so will only be possible if suitable surplus funds are available.
It is possible to use a combination of these strategies in order to reduce the profit gap, provided
resources are available.

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SECTION B

3 Glenn Associates
Marking scheme
Marks
(a) Weakness of traditional measures 1
Importance of other areas of performance 1
Widen managers focus 1
Application to service industry 1
4
(b) 3 marks per NFPI plus explanation Max 16
20

Suggested solution
(a) It is now fairly widely recognised that concentration on financial performance indicators alone is
too narrow a focus for businesses and means that important goals and factors may be ignored.
This is particularly true of service industries such as that of GA where the quality and flexibility of
service that they provide to their customers is of extreme importance in a competitive market.
In the current business environment factors such as quality, delivery, reliability, after sales service
and customer satisfaction are vital to continued success of any business. Such elements of a
business cannot be quantified and reported using the traditional financial performance indicators
such as profit margins and return on capital employed.
For GA, non-financial performance indicators are of very great importance as the reputation of
their business relies upon not only the reliability of the product that they supply, the security
system, but also the service that they provide in terms of their speed and quality of installation and
emergency response and their reliability in terms of servicing of the security systems.
Further, managers are more likely to narrow their focus if only financial performance indicators are
considered. Non-financial performance indicators will tend to make managers consider external
factors such as customers and competitors. This in turn can result in managers thinking more
strategically about the business and making decisions to improve service rather than increase
short run profit or profitability.
(b) Competitiveness
Percentage of enquiries turned into contracts
New business (3,005/4,230) 71.0%
Repeat business (1,510/1,840) 82.1%
This indicates how well GA turns enquiries about business into contracts and is therefore an
indication as to how competitive they are at winning new contracts from both new business
customers and existing customers. In particular, the percentage of new business is a useful
indicator due to strategic objective of increasing the customer base.
Increase in number of contracts:
Service (18,890 – 15,890)/15,890 18.9%
Installations (9,635 – 8,120)/8,120 18.7%
This gives an indication of growth in the business rather than simply considering growth in
turnover. The break down between service and installation contracts provides management with
information about which section of the business is more competitive. The increase in installations
contracts is of particular importance as it is recognised that new installations lead to an increase in
service contracts thereafter, so GA should see the service percentage rise in future periods.

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Resource utilisation
Number of service call outs per engineer
(14,320/95) 150.7 per engineer
This indicates the productivity of the service engineers. Productivity is an important aspect of cost
control as the salaries of the engineers will be fixed costs of the business. The more service call-
outs made by each engineer will reduce the salary costs per call out and increase profit per call
out.
Percentage of chargeable hours to total hours
Installations (62,830/68,300) 92.0%
Service (166,790/213,750) 78.0%
Again this indicates the productivity of each type of engineer. As above the greater the
productivity of the engineers the lower will be the cost per installation and cost per service. Care
must be taken when setting standards in this area. Given the need for emergency cover and to
maintain flexibility, GA will need to accept some spare capacity.
Quality
Customer complaints as percentage of contracts
Installations (934/9,635) 9.7%
Service contracts (1,250/18,890) 6.6%
This shows the level of customer satisfaction with the work carried out and indicates the quality of
the work of the engineers. In a service industry such as this, quality of both the product and the
service provided is of vital importance in retaining customers and the directors of GA recognise
this as part of their overall strategy.
Time to reach client 3.2 hours on average
Time between enquiry and installation 5 days on average
Both of these indicators are important factors as customers will assess GA not only on the quality
of their product and their engineers but also on the speed of dealing with problems and getting a
new installation in place. Again as above this ties in with the strategic objective of providing the
highest quality of service. These are the indicators that may suffer if too much pressure is applied
to resource utilisation.

15
4 Edwards Incorporated
Marking scheme
Marks
(a) ROI 2
RI 2
Explanation of manager’s reaction 2
Board reaction 2
EVA calculation 3
EVA commentary 1
12
(b) 2 marks per reason (1 for identification, 1 for explanation) 4

(c) 1 mark per valid issue Max 4

20

Suggested solution
Profit before interest and tax
(a) (i) Return on investment = x 100
Average capital investment

Opening capital investment = $1,000,000

Closing capital investment (1,000,000 x ¾) = $750,000
Average capital investment = ($1,000,000 + 750,000)/2
= $875,000
$120,000
Return on investment =
$875,000
= 13.7%
Residual income
Profit before interest and tax $120,000
Interest cost on average investment $875,000 x 10% $87,500
Residual income $32,500
The return on investment of the project in the first year is only 13.7% which is lower than
the current return on investment for TT of 15.8%. Therefore the manager of TT is unlikely
to invest in this project as it will reduce his division’s return on investment in the short term
and therefore affect the amount of bonus which he will be paid for this year.
However the project has an overall positive net present value of $0.35 million and has a
positive residual income in this first year of $32,500. Both of these measures mean that
the investment would be suitable for the company overall and therefore the Board of
directors of EI would want TT to invest in this project.
(iii) Economic value added
EVA = Net operating profit after tax – capital charge
Capital charge = Weighted average cost of capital x economic value of net assets
Net operating profit after tax
$000
Profit after tax per question 90
Add back advertising cost 40
NOPAT 130
Value of net assets at start of period 1,000
At 10% charge 100
EVA 30

16
 As the economic value added of the investment is positive the manager of TT concluded
that the investment will add to the wealth of the shareholders and therefore should be
undertaken.
(b) The performance of a division must be assessed separately from that of a manger for the
following reasons:
• An astute manager may have been put in charge of a poorly performing division. He may
have improved the division’s performance due to his own ability but if the division is still
performing poorly then divisional measurements will not reflect the performance of the
manager.
• Many strategic decisions take time to affect results. A manager should be assessed on the
value added to a division rather than on reported profits. Strategic decisions may not
always be available if capital budgets are set by head office.
• Managers have skills and attributes that cannot be assessed by considering divisional
returns .Managerial ability will require separate measurement.
• Managers may not have control over all costs. The manager of a division should only be
held accountable for costs over which he has some influence. However it is not always
easy to determine controllable and non-controllable costs in practice. Some costs may be
under the control of a senior manager but not a junior manager. Some costs may be under
joint control of two or more managers.
• In a divisionalised business such as EI some costs are controlled by a manager in another
division. Costs and revenues will be created by a system of transfer prices, which may
have been determined by higher levels of management rather than the manager being
assessed.
• Many divisions are also charged with costs from head office. These may be apportioned to
divisions irrespective of use, in a manner that the divisional manger cannot control.
(note: only FOUR reasons required)
(c) The problems of comparing divisional performance when divisions are in different countries
include:
Market conditions
The economic climate in different countries will affect the reported performance of divisions within
those countries. Economic factors may include different inflation rates, changing exchange rates, the
state of the economic cycle in the country, interest rates and local taxation policy.
Political climate
Political factors that may affect performance include the attitude of the local government to that
particular industry, incentives or grants which may be allowed, effects on competition or regulations
and controls in that particular industry.
Funding
The availability of funds for investment from country to country may differ and this is likely to affect the
ability to invest and also the cost of investment if the funds are available.
Legal factors
Different countries may have different laws and regulations in areas such as health and safety,
minimum wages, consumer protection, pollution control and waste disposal. All of these are likely to
affect the performance of a division.

17
5 Management accounting and reporting
Marking scheme
Marks
(a) No “correct” model 1
Environmental factors 5
Technological factors 2
Organisation factors 2
10
(b) Open systems 2
Closed systems 3
5
(c) Controls over generation (max 1 per point) 3
Controls over distribution 3
Max 5
20

Suggested solution
(a) In all but the most simple of business situations there will always be an element of uncertainty and
different factors will affect different businesses. Therefore there can be no universally accepted
model for a management accounting system as this must be tailored to the situation of each
individual business. Management accounting systems must not only be specifically tailored to the
business but be capable of change as changes occur in the business environment.
The fact that there is this element of uncertainty is a major factor which affects the design of
management accounting systems and this is often known as contingency theory.
Contingent factors can be classified as relating to environment, technology and organisation.
Environment
One of the key external factors which will affect the design of a management accounting system is
the element of competition in which the business operates. In an extreme case where a business
has no form of competition for the sale of its products then the requirements of the management
accounting system will be very simple. However if there are competitors in the market then this
will necessarily mean that more management accounting information is required about prices,
costs, market size, market share and any information that can be found about those competitors.
As competition from other firms becomes more severe then there will be a necessity for more
complex management accounting information to be prepared including non-financial information.
The amount of change in a business will also be an important element in the management
accounting system that is required. If the business operates in a dynamic environment which is
constantly changing then more frequent reporting will be required under the management
accounting system. Equally if there is a major change in the circumstances in which a business
operates such as expansion overseas then this will inevitably require changes in the
management accounting system.

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 Technology
Quite clearly the nature of the production process in an organisation will dictate to a large
extent the type of management accounting system that is required. This also applies to service
industries with high overheads which will require a different type of management accounting
system to that of a manufacturing organisation.
If a manufacturing process is complex, then more things could go wrong and a more complex
system of accounting will be needed. This will particularly apply to operational units within an
organisation.
Organisation
The size, nature and culture of an organisation will have an effect on its management accounting
system. If the nature of a business changes due to acquisition by another organisation then it is
likely the acquiring company will impose its systems on the acquiree. The management
accounting system must be in line with the culture of the organisation and with the power structure
and must be adaptable enough to change where there are changes in these factors.
The management accounting system will also be affected by the organisational structure of the
business A simple manufacturing business will be organised on a functional basis and
management reporting will also be on that basis. However where the organisation expands into
different products and different markets then it is likely to take on a divisional structure requiring
completely different forms of management information. The same information supplied for the
simple business can be re-produced for the individual divisions, but a system to consolidate this
will be required.
A more complex business structure with many divisions, some of whom service other divisions,
and with transfer prices involved will necessarily require a more complex management accounting
system.
(b) A closed system is a system which is isolated from outside influences and external factors and is
unaffected by the environment in which it operates. It also does not influence the environment in
which it operates. The most common example of closed system which tends to be cited is that of
a chemical reaction which takes place in a laboratory environment.
Closed systems are seldom found in naturally occurring situations, including business situations
as they are unable to react to environmental influences. as a result they have few merits for
business and performance management.
In contrast an open system is one which is connected to its environment, interacts with it, is
influenced by it and in turn affects the environment in which it operates.
Typically an open system will accept input from its environment, process the input in some way
and produce an output. Both inputs and outputs may be either predicted or unforeseen.
A management accounting system needs to be an open system. The inputs and outputs of a
business are affected by suppliers, employees, customers, competitors, the government and
society. New outputs may need to be generated to cope with disturbances and thus new input will
need to be collected and processed.
(c) It is vital that controls are in place over both the generation and distribution of this information.
Generation:
Information will include both routine reports and ad hoc reports but the principles regarding their
generation will be very similar.
• It must be clear that the preparation of the report is worthwhile. There must be some form
of cost/benefit analysis to ensure that the usefulness of the report is worth the time that it
will take to prepare.

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• If a report is to be used regularly then it should firstly be given a trial run by preparing a
prototype to ensure that the correct information is being provided in a useful format. The
usefulness of the report for information provision should also be reassessed on a regular
basis.
• Standard reports should be prepared on a consistent basis with the same format and
definitions each time it is produced. Often a company will also have as house style for
such reports.
• Most reports will require some form of action from someone therefore the originator of the
report must be clearly identified in case of any queries and the report should set out clearly
limits to the action that should be taken as a result of the report.
Distribution:
• The principles and procedures regarding distribution of internal information should be set
out in a procedures manual. Amongst other matters this will include details of which
standard reports should be produced and when, to whom these reports should be sent and
the format of the report.
• The procedures manual should also make clear what information should be regarded as
confidential and how to dispose of reports, ie shredded, thrown away or filed.
• Confidentiality is a key issue. In general all employees should have signed contracts in
which they agree not to divulge confidential information.
• In particular any payroll and personnel information is highly confidential and should be kept
either physically locked away or if kept on computer protected by password access.
(Note: only 3 points required in either section)

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