Performance Management Study System

2012 EDITION | Study System
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ACCA
Paper P5 | ADVANCED PERFORMANCE
MANAGEMENT
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2012 DeVry/Becker Educational Development Corp. All rights reserved.

ACCA

PAPER P5
ADVANCED PERFORMANCE MANAGEMENT

STUDY SYSTEM

JUNE 2012

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2012 DeVry/Becker Educational Development Corp. All rights reserved.
No responsibility for loss occasioned to any person acting or refraining from action as a result of any
material in this publication can be accepted by the author, editor or publisher.
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SESSION 00 CONTENTS
2012 DeVry/Becker Educational Development Corp. All rights reserved. (iii)
CONTENTS
Page
Introduction (iv)
Syllabus (v)
Study Guide (ix)
Exam technique (xvi)
1 Introduction to Strategic management accounting 0101
2 Performance management and control of the organisation 0201
3 Changes in business structure and management accounting 0301
4 Effect of IT on modern management accounting 0401
5 Other environmental and ethical issues 0501
6 External influences on organisational performance 0601
7 Performance management information systems 0701
8 Information recording and reporting 0801
9 The performance hierarchy 0901
10 Performance measurement in the private sector 1001
11 Divisional performance evaluation 1101
12 Transfer pricing 1201
13 Not-for-profit organisations 1301
14 Non-financial performance indicators and quality 1401
15 Human aspects of performance management 1501
16 Alternative views of performance management 1601
17 Complex business structures 1701
18 Current developments 1801
Index 1901

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SESSION 00 INTRODUCTION
(iv) 2012 DeVry/Becker Educational Development Corp. All rights reserved.
Introduction
This Study System has been specifically written for the Association of Chartered Certified
Accountants fundamentals level examination, Paper P5 Advanced Performance Management.
It provides comprehensive coverage of the core syllabus areas and is designed to be used
both as a reference text and and is designed to be used both as a reference text and as to
provide you with the knowledge, skill and confidence to succeed in your ACCA
examinations.
About the author: Nick Ryan is ATC Internationals lead tutor in performance management
and has more than 10 years experience in delivering ACCA exam-based training.
How to use this Study System
You should first read through the syllabus, study guide and approach to examining the
syllabus provided in this session to familiarise you with the content of this paper. The
sessions which follow include:
An overview diagram at the beginning of each session.
This provides a visual summary of the topics covered in each Session
and how they are related.

The body of knowledge which underpins the syllabus. Features of the
text include:

Definitions Terms are defined as they are introduced.

Illustrations These are to be read as part of the text. Any solutions
to numerical illustrations follow on immediately.

Examples These should be attempted using the proforma
solution provided (where applicable).

Key points Attention is drawn to fundamental rules and
underlying concepts and principles.

Commentaries These provide additional information.

Focus These are the learning outcomes relevant to the
session, as published in ACCAs Study Guide.

Example solutions are presented at the end of each session.
A bank of practice questions is contained in the Study Question Bank provided. These are
linked to the topics of each session and should be attempted after studying each session.
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SESSION 00 SYLLABUS
2012 DeVry/Becker Educational Development Corp. All rights reserved. (v)
SYLLABUS
Aim
To apply relevant knowledge, skills and exercise professional judgement in selecting and
applying strategic management accounting techniques in different business contexts and to
contribute to the evaluation of the performance of an organisation and its strategic
development.
Main capabilities
On successful completion of this paper, candidates should be able to:
A Use strategic planning and control models to plan and monitor organisational
performance;
B Assess and identify relevant macro economic, fiscal and market factors and key external
influences on organisational performance;
C Identify and evaluate the design features of effective performance management
information and monitoring systems;
D Apply appropriate strategic performance measurement techniques in evaluating and
improving organisational performance;
E Advise clients and senior management on strategic business performance evaluation
and on recognising vulnerability to corporate failure;
F Identify and assess the impact of current developments in management accounting and
performance management on measuring, evaluating and improving organisational
performance.
Syllabus structure
APM (P5)
PM (F5)
MA (F2)
BA (P3)

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SESSION 00 SYLLABUS
(vi) 2012 DeVry/Becker Educational Development Corp. All rights reserved.
Relational diagram of main capabilities
Strategic planning and control (A)
Economic, fiscal, market and environmental factors (B)

Performance measurement
systems and design (C)
Performance evaluation and corporate failure (E)
Current developments and emerging issues in management accounting
and performance management (F)
Strategic performance
measurement (D)

Rationale
The Advanced Performance Management syllabus further develops key aspects introduced
in Paper F5, Performance Management, at the skills level and draws on aspects of the material
covered from a more strategic and operational planning perspective in Paper P3, Business
Analysis.
The syllabus introduces candidates to the strategic role of management accounting as a
discipline for planning and controlling performance so that strategic objectives can be set,
monitored and controlled. It also covers the impact of external factors on strategic
management issues, such as macro economic, fiscal, market and environmental impacts on
performance. From appreciating the strategic context of performance management and the
impact of wider factors, the syllabus examines, at an operational level, the issues relating to
performance measurement systems and their design.
The syllabus then moves from performance management systems and their design to the
scope and application of high-level performance measurement techniques in a variety of
contexts, including not-for-profit organisations and multinational businesses. Having
covered the strategic aspects of performance management and operational systems for the
measurement and control of performance in a variety of contexts, candidates are then
expected to synthesise this knowledge in the role of an advisor to senior management or
independent clients on how to assess and control the performance of an entity, including the
recognition of whether a business is facing difficulties or possibly failure.
Finally, the syllabus deals with current developments in performance management and with
emerging issues as they might affect or influence the management of performance within
organisations.
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SESSION 00 SYLLABUS
2012 DeVry/Becker Educational Development Corp. All rights reserved. (vii)
DETAILED SYLLABUS
A. Strategic planning and control
1. Introduction to strategic management accounting
2. Performance management and control of the organisation
3. Changes in business structure and management accounting
4. Effect of Information Technology (IT) on strategic management accounting
5. Other environmental and ethical issues
B. External influences on organisational Performance
1. Changing business environment
2. Impact of external factors on strategy and performance
C. Performance measurement systems and design
1. Performance management information systems
2. Sources of management information
3. Recording and processing methods
4. Management reports
D. Strategic performance measurement
1. Performance hierarchy
2. Strategic performance measures in private sector
3. Divisional performance and transfer pricing issues
4. Strategic performance measures in not-for-profit organisations
5. Non-financial performance indictors
6. The role of quality in management information and performance measurement systems
7. Performance measurement and strategic human resource management issues
8. Performance measurement and the reward systems
9. Other behavioural aspects of performance measurement
E. Performance evaluation and corporate failure
1. Alternative views of performance measurement and management
2. Strategic performance issues in complex business structures
3. Predicting and preventing corporate failure
F. Current developments and emerging issues performance management
1. Current developments in management accounting techniques
2. Current issues and trends in performance management
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SESSION 00 SYLLABUS
(viii) 2012 DeVry/Becker Educational Development Corp. All rights reserved.
Approach to examining the syllabus
Paper P5 builds on paper F5, Performance Management, and candidates are expected to have a
thorough understanding of the paper F5 syllabus. In addition, candidates will also be
required to apply the principles and techniques covered in paper F2, Management
Accounting.
Paper P5 has a link with Paper P3, Business Analysis, in the areas of strategic planning and
control and performance measurement
Structure of the examination paper
The examination paper will comprise two sections:
Section A
Section A will comprise two compulsory questions comprising between 50 and 70 marks in
total. Each question will comprise of between 25 and 40 marks.
Section B
In section B candidates will be asked to answer two from three questions comprising of
between 15 and 25 marks each.
Total 100 marks
ACCA Support
For examiners reports, guidance and technical articles relevant to this paper see
http://www2.accaglobal.com/students/acca/exams/p5/
The ACCAs Study Guide which follows is referenced to the Sessions in this Study System.

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SESSION 00 STUDY GUIDE
2012 DeVry/Becker Educational Development Corp. All rights reserved. (ix)
STUDY GUIDE
A STRATEGIC PLANNING AND
CONTROL
1. Introduction to strategic
management accounting
Explain the role of strategic
performance management in
strategic planning and control.
Discuss the role of corporate
planning in clarifying corporate
objectives, making strategic
decisions and checking progress
towards the objectives.
Compare planning and control
between the strategic and
operational levels within a business
entity.
Assess the use of strategic
management accounting in the
context of multinational companies.
Discuss the scope for potential
conflict between strategic business
plans and short-term localised
decisions.
Evaluate how SWOT analysis may
assist in the performance
management process.
Evaluate the methods of bench
marking performance.
2. Performance management and
control of the organisation
Evaluate the strengths and
weaknesses of alternative
budgeting models and compare
such techniques as fixed and
flexible, rolling, activity based, zero
based and incremental.
Assess how budgeting may differ in
not-for-profit organisations from
profit-seeking organisations.
Evaluate the impact to an
organisation of a move beyond
budgeting.
Ref:

1

2

3. Changes in business structure and
Identify and discuss the particular
information needs of organisations
adopting a functional, divisional or
network form and the implications
for performance management.
Assess the influence of Business
Process Re-engineering on systems
development and improvements in
organisational performance.
Discuss the concept of business
integration and the linkage between
people, operations, strategy and
technology.
Identify and discuss the required
changes in management accounting
systems as a consequence of
empowering staff to manage sectors
of a business.
4. Effect of Information Technology
(IT) on strategic management
accounting
Assess the changing accounting
needs of modern service orientated
businesses compared with the
needs of traditional manufacturing
industry.
Discuss how IT systems provide the
opportunity for instant access to
management accounting data
throughout the organisation and
their potential impact on business
performance.
Discuss how IT systems facilitate
the remote input of management
accounting data in an acceptable
format by non-finance specialists.

Ref:

3

4

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Explain how information systems
provide instant access to previously
unavailable data that can be used
for benchmarking and control
purposes and help improve
business performance.
Assess the need for businesses to
continually refine and develop their
management accounting and
information systems if they are to
maintain or improve their
performance in an increasingly
competitive and global market.
5. Other environmental and ethical
issues
Discuss the ways in which
stakeholder groups operate and
how they affect an organisation and
its strategy formulation and
implementation.
Discuss the ethical issues that may
impact on strategy formulation and
Discuss the ways in which
stakeholder groups may influence
B EXTERNAL INFLUENCES ON
ORGANISATIONAL
PERFORMANCE
1. Changing business environment
Assess the continuing effectiveness
of traditional management
accounting techniques within a
rapidly changing business
environment.
Evaluate how risk and uncertainty
play an important role in long term
strategic planning and decision-
making that relies upon forecasts of
exogenous variables.
Ref:

5

6
2. Impact of external factors on
strategy and performance
Discuss the need to consider the
environment in which an
organisation is operating when
assessing its performance,
including:
Political climate
Market conditions
Funding.

Assess the impact of governmental
regulations and policies on
performance measurement
techniques used and the
performance levels achieved (for
example, in the case of utility
services and former state
monopolies).
C PERFORMANCE
MEASUREMENT SYSTEMS AND
DESIGN
1. Performance management
information systems
Identify the accounting information
requirements and describe the
different types of information
systems used for strategic planning,
management control and
operational control and decision-
making.
Discuss, with reference to
performance management, ways in
which the information
requirements of a management
structure are affected by the
features of the structure.
Evaluate the compatibility of the
objectives of management
accounting and management
accounting information.

Ref:
6

7
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Discuss the integration of
information within an overall
information system, for example the
use of enterprise resource planning
systems.
Evaluate whether the management
information systems are lean and
value of the information that they
provide.
Define and discuss the merits of,
and potential problems with, open
and closed systems with regard to
the needs of performance
management.
Highlight the ways in which
contingent (internal and external)
factors influence management
accounting and its design and use.
Advise how anticipated human
behaviour will influence the design
of a management accounting
system.
Discuss the impact of responsibility
accounting on information
requirements.
2. Sources of management
information
Identify and discuss the principal
internal and external sources of
information.
Demonstrate how these principal
sources of management information
might be used for control purposes.
Identify and discuss the direct data
capture and process costs of
information.
Identify and discuss the indirect
costs of producing information.
Discuss the limitations of using
externally generated information.
Ref:

8

Demonstrate how the information
might be used in planning and
controlling activities (e.g.
benchmarking against similar
activities).
Discuss those factors that need to be
considered when determining the
capacity and development potential
of a system.
3. Recording and processing methods
Demonstrate how the type of
business entity will influence the
recording and processing methods.
Discuss how IT developments (e.g.
unified corporate databases and
network technology) may influence
management accounting systems.
Discuss the difficulties associated
with recording and processing data
of a qualitative nature.
4. Management reports
Discuss the principal controls
required in generating and
distributing internal information.
Discuss the procedures that may be
necessary to ensure security of
highly confidential information that
is not for external consumption.
Evaluate the output reports of an
information system in the light of
best practice and avoiding the
problem of information overload.
D STRATEGIC PERFORMANCE
MEASUREMENT
1. Performance hierarchy
Discuss how the purpose, structure
and content of a mission statement
impacts on business performance.
Discuss the ways in which high-
level corporate performance
objectives are developed.
Ref:
8

8

8

9

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Identify strategic objectives and
discuss how they may be
incorporated into the business plan.
Discuss how strategic objectives are
cascaded down the organisation via
the formulation of subsidiary
performance objectives.
Discuss social and ethical
obligations that should be
considered in the pursuit of
corporate performance objectives.
Explain the performance planning
gap and evaluate alternative
strategies to fill that gap.
Apply critical success factor
analysis in developing performance
metrics from business objectives.
Identify and discuss the
characteristics of operational
performance.
Discuss the relative significance of
planning as against controlling
activities at different levels in the
performance hierarchy.
2. Strategic performance measures in
private sector
Demonstrate why the primary
objective of financial performance
should be primarily concerned with
the benefits to shareholders.
Justify the crucial objectives of
survival and business growth.
Discuss the appropriateness of, and
apply different measures of
performance, including:
Return on Capital Employed
(ROCE)
Return on Investment (ROI)
Earnings Per Share (EPS)
Earnings Before Interest, Tax,
Depreciation and Amortisation
(EBITDA)
Ref:

10

Residual Income (RI)
Net Present value (NPV)
Internal rate of return and
modified internal Rate of
Return (IRR, MIRR).

Discuss why indicators of liquidity
and gearing need to considered in
conjunction with profitability.
Compare and contrast short and
long run financial performance and
the resulting management issues.
Explore the traditional relationship
between profits and share value
with the long-term profit
expectations of the stock market
and recent financial performance of
new technology companies.
Assess the relative financial
performance of the organisation
compared to appropriate
benchmarks.
Discuss and apply Six Sigma
measures of performance.
3. Divisional performance and transfer
pricing issues
Describe, compute and evaluate
performance measures relevant in a
divisionalised organisation
structure including ROI, RI and
Economic value added (EVA).
Discuss the need for separate
measures in respect of managerial
and divisional performance.
Discuss the circumstances in which
a transfer pricing policy may be
needed and discuss the necessary
criteria for its design.
Demonstrate and evaluate the use
of alternative bases for transfer
pricing.
Ref:

11

11

12

12

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Explain and demonstrate issues that
require consideration when setting
transfer prices in multinational
companies.
4. Strategic performance measures in
not-for-profit organisations
Highlight and discuss the potential
for diversity in objectives
depending on organisation type.
Discuss the need to achieve
objectives with limited funds that
may not be controllable.
Identify and discuss ways in which
performance may be judged in not-
for profit organisations.
Discuss the difficulties in
measuring outputs when
performance is not judged in terms
of money or an easily quantifiable
objective.
Discuss how the combination of
politics and the desire to measure
public sector performance may
result in undesirable service
outcomes.
Assess value for money service
provision as a measure of
performance in not-for-profit
organisations and the public sector.
5. Non-financial performance
indicators
Discuss the interaction of non-
financial performance indicators
with financial performance
indicators.
Discuss the implications of the
growing emphasis on non-financial
performance indicators.
Discuss the significance of non-
financial performance indicators in
relation to employees.
Ref:
12

13

14

Identify and discuss the significance
of non-financial performance
indicators in relation to
product/service quality (e.g.
customer satisfaction reports, repeat
business ratings, customer loyalty,
access and availability).
Discuss the difficulties in
interpreting data on qualitative
issues.
Discuss the significance of brand
awareness and company profile
and their potential impact on
6. The role of quality in management
information and performance
measurement systems
Discuss and evaluate the
application of Japanese business
practices and management
accounting techniques, including:
Kaizen costing,
Target costing,
Just-in-time, and
Total Quality Management.

Discriminate between quality,
quality assurance, quality control
and quality management.
Assess the relationship of quality
management to the performance
management strategy of an
organisation.
Advise on the structure and
benefits of quality management
systems and quality certification.
Justify the need and assess the
characteristics of quality in
management information systems.

Ref:

14

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7. Performance measurement and
strategic Human Resource
Management issues
Explain how the effective
recruitment, management and
motivation of people is necessary
for enabling strategic and
operational success.
Discuss the judgemental and
developmental roles of assessment
and appraisal and their role in
improving business performance.
Advise on the relationship of
performance management to
(performance rating) and determine
the implications of performance
measurement to quality initiatives
and process redesign.
8. Performance measurement and the
reward systems
Explore the meaning and scope of
reward systems.
Discuss and evaluate different
methods of reward practices.
Explore the principles and difficulty
of aligning reward practices with
strategy.
Advise on the relationship of
reward management to quality
initiatives, process re-design and
harnessing of e-business
opportunities.
Assess the potential beneficial and
adverse consequences of linking
reward schemes to performance
measurement, for example, how it
can affect the risk appetite of
employees.
9 Other behaviour aspects of
Discuss the accountability issues
that might arise from performance
measurement systems.
Ref:
15

15

15

Evaluate the ways in which
performance measurements
systems may send the wrong
signals and result in undesirable
business consequences.
Demonstrate how management
style needs to be considered when
designing an effective performance
measurement system.
E PERFORMANCE EVALUATION
AND CORPORATE FAILURE
1. Alternative views of performance
measurement and management
Evaluate the balanced scorecard
approach as a way in which to
improve the range and linkage
between performance measures.
Evaluate the performance
pyramid as a way in which to link
strategy, operations and
performance.
Evaluate the work of Fitzgerald and
Moon that considers performance
measurement in business services
using building blocks for
dimensions, standards and
rewards.
Discuss and apply the Performance
Prism.
Discuss and evaluate the
application of activity-based
management.
Evaluate and apply the value-based
management approaches to
performance management.
2. Strategic performance issues in
complex business structures
Evaluate the use and the
application of strategic models in
assessing the business performance
of an entity, such as Ansoff, Boston
Consulting Group and Porter.
Ref:

16

17
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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xv)

Discuss the problems encountered
in planning, controlling and
measuring performance levels (e.g.
productivity, profitability, quality
and service levels) in complex
business structures.
Discuss the impact on performance
management of the use of business
models involving strategic
alliances, joint ventures and
complex supply chain structures.
3. Predicting and preventing corporate
failure
Assess the potential likelihood of
corporate failure, utilising
quantitative and qualitative
performance measures.
Assess and critique quantitative
and qualitative corporate failure
prediction models.
Identify and discuss performance
improvement strategies that may be
adopted in order to prevent
corporate failure.
Discuss how long-term survival
necessitates consideration of life-
cycle issues.
Identify and discuss operational
changes to performance
management systems required to
implement the performance
improvement strategies.
Ref:

17
F. CURRENT DEVELOPMENTS
AND EMERGING ISSUES IN
PERFORMANCE MANAGEMENT
1. Current developments in
techniques
Discuss the ways through which
practitioners are made aware of
new techniques and how they
evaluate them.
Discuss, evaluate and apply
environmental management
accounting.
Discuss the use of benchmarking in
public sector performance (league
tables) and its effects on operational
and strategic management and
client behaviour.
Discuss the issues surrounding the
use of targets in public sector
organisations.
2. Current issues and trends in
performance management
Assess the changing role of the
management accountant in todays
business environment as outlined
by Burns and Scapens.
Discuss contemporary issues in
performance management.
Discuss how changing
organisations structure, culture
and strategy will influence the
adoption of new performance
measurement methods and
techniques.
Ref:

18

18
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SESSION 00 EXAM TECHNIQUE
(xvi) 2012 DeVry/Becker Educational Development Corp. All rights reserved.
EXAM TECHNIQUE
Reading and planning time
The following is the suggested approach to the reading and planning time for paper P5.
Read the requirements of all parts of all questions.
Decide which order you will do the questions in. This also means deciding which of the
Section B questions to do.
Plan you time. Remember you have to allocate 1.8 marks of exam time to each mark
available. On the front page of your question paper, write down the time that you will
start each question.
With any remaining time left, start to read the scenario from one of the long Section A
questions, and start to plan. It is unlikely you will have time to plan it completely
during reading and planning time.
Overall exam strategy
For most candidates, it is probably best to do the two Section A questions first, while you are
relatively fresh. If you suffer badly from exam nerves however, you may wish to do your
best question from Section B first, to get you settled into the exam. At any rate, you are not
advised under any circumstances to do the Section A questions last.
Do stick to your time allocation, and do attempt all questions. Even if a question looks
difficult, there will always be easy marks.
Remember that in P5, the examiner is looking for you to apply your knowledge to real life
scenarios and not just to regurgitate what is in your text book. Do refer to the case scenarios
in your answers.
Section A questions
Section A will be scenario type questions. The examiner has said that there will be a lot of
reading required.
During the planning time
Briefly read the initial paragraphs to gain a broad understanding of the scenario.
Read the requirements of all parts of the question.
Read through the scenario briefly to get a quick understanding of the case.
Think about what is required. What do you need to do?
Read the scenario more slowly. This time underline key information, make any relevant
notes and reference to the relevant parts of the question.
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2012 DeVry/Becker Educational Development Corp. All rights reserved. (xvii)
For numerical parts of the question, think about your route to get to the answer. What
calculations will you perform, how will your workings be laid out. It there a simpler
way? The current P5 examiner does not generally require too much calculation
however.
Ensure that you have incorporated hints and facts from the scenario, particularly in
written questions. Remember, this examiner does not normally provide superfluous
information in his scenarios. If information is provided, it is there for a reason!
Section B Numerical questions
Before starting a computation, picture your route. Do this by jotting down the steps you
are going to take and imagining the layout of your answer.
Set up a pro-forma structure to your answer before working the numbers.
Use a columnar layout if appropriate. This helps to avoid mistakes and is easier for the
marker to follow.
Include all your workings and cross-reference them to the face of your answer.
A clear approach and workings will help earn marks even if you make an arithmetic
mistake.
If you do spot a mistake in your answer, it is not worthwhile spending time amending
the consequent effects of it. The marker of your script will not punish you for errors
caused by an earlier mistake.
Dont ignore marks for written recommendations or comments based upon your
computation. These are easy marks to gain.
If you could not complete the calculations required for comment then assume an answer
to the calculations. As long as your comments are consistent with your assumed
answer you can still pick up all the marks for the comments.
Written questions
Planning
Read the requirements carefully at least twice to identify exactly how many points you are
being asked to address.
Jot down relevant thoughts on your plan
Give your plan a structure which you will follow when you write up the answer.
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(xviii) 2012 DeVry/Becker Educational Development Corp. All rights reserved.
Presentation
Use headings, indentation and bullet points to give your answer structure and to make it
more digestible for the marker.
Use short paragraphs for each point that you are making.
Use bullet points where this seems appropriate.
Separate paragraphs by leaving at least one line of space between each one.

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SESSION 01 INTRODUCTION TO STRATEGIC MANAGEMENT ACCOUNTING
2012 DeVry/Becker Educational Development Corp. All rights reserved. 0101
OVERVIEW
Objective
To introduce strategic management accounting.

PLANNING AND
CONTROL AT
DIFFERENT LEVELS
Role of corporate planning
Overall planning framework
External analysis
Internal analysis
Setting objectives
Gap analysis
Selection of strategies
Strategic control
BENCHMARKING
CORPORATE
PLANNING &
STRATEGY
SWOT
ANALYSIS
Anthonys model
MULTINATIONAL
COMPANIES
Role of management accounting
Different types of organisation
Internal and external analysis
Benefits

STRATEGIC
PERFORMANCE
MANAGEMENT
POTENTIAL
CONFLICTS
Formal approach to strategic planning
Reasons for conflict
Potential solutions to the conflict
Management accounting
Traditional management accounting
Strategic management accounting
Strategic management accounting tools
Internally set standards
Types of benchmarking
Stages
Benefits of benchmarking
Difficulties

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0102 2012 DeVry/Becker Educational Development Corp. All rights reserved.
1 STRATEGIC PERFORMANCE MANAGEMENT
1.1 Management accounting
Management accounting is concerned with the provision of information to enable
management to:
formulate policies;
plan and control activities (including safeguarding assets);
make decisions on alternative courses of action.
Paper P5 Advanced Performance Management is an advanced management accounting paper,
which looks at the nature of management accounting and discusses whether or not that
information helps organisations to improve their performance. Performance management
involves designing systems for measuring the performance of organisations and the people
who work in those organisations. Performance is measured based on how well the
organisation is meeting its strategic objectives. The paper also looks at the latest
developments in management accounting.
1.2 Traditional management accounting
1.2.1 Meaning of traditional management accounting
Traditional management accounting includes areas such as:
Cost accounting;
Budgeting;
Variance analysis.
Many of these techniques were developed in the late nineteenth century.
Commentary

You should already be familiar with traditional management accounting techniques
from earlier ACCA studies.

1.2.2 Lost relevance of traditional management accounting techniques
In the latter part of the twentieth century, many management writers argued that
management accounting had lost its relevance. In particular, it was criticised for being too
inwardly focused. As the business world in which organisations exist has become
increasingly competitive and dynamic, it is essential for managers to focus on both internal
and external factors.
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1.3 Strategic management accounting (Strategic performance management)
Since the 1980s management writers have proposed that management accounting should
become broader in focus, and more strategic in nature. The term Strategic management
accounting or Strategic performance management has been widely used since then to
refer to an extended role of management accountants. There is no universally accepted
definition of the scope of strategic management accounting the term means different things
to different writers. In general terms it is usually taken to mean:
The provision of information to support strategic planning and decision making in
organisations;
The provision of information that is external as well as internal;
The use of non-financial as well as financial information;
The provision of information to support the competitive advantages of an organisation.
1.4 Some strategic management accounting tools
The following tools are examples of strategic management accounting:
The use of activity based costing and activity based management;
Analysis of competitors using tools such as Benchmarking;
Value chain analysis to gain competitive advantage.
These are covered in later sessions.
2 CORPORATE PLANNING & STRATEGY
2.1 Role of corporate planning
Corporate planning involves formulating an organisations strategy, and converting this into
shorter term objectives, possibly by way of a formal plan. Targets may then be set, and the
performance of an organisation is measured against these targets. Performance
Management is all about defining the organisations strategy, and measuring how the
organisation is performing in relation to achieving its strategy.
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2.2 Overall planning framework
The following basic model of financial planning demonstrates how corporate objectives may
be formulated, and strategies developed to achieve these objectives.
EXTERNAL
ANALYSIS
INTERNAL
ANALYSIS
POSITION
ANALYSIS
(SWOT)
MISSION,
STAKEHOLDER
OBJECTIVES,
SPECIFIC
OBJECTIVES
GAP
OVERALL
STRATEGY
INTERNAL
STRATEGY
INVESTMENT
STRATEGY
FINANCING
STRATEGY

This approach to planning is outward looking, since it considers the external as well as the
internal environment and enables realistic objectives to be set and the development of
strategies which follow logically from the current position.
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2.3 External analysis
This requires a review of environmental influences on the organisation such as:
Political situation;
Legal framework pollution controls;
Economic factors interest rates, exchange controls;
Socio-cultural factors demography of the market;
Technology new production processes;
Competitive environment new entrant to the market, substitute products, etc.
This analysis should reveal external opportunities and threats. External analysis is covered
in more detail in Session 5.
2.4 Internal analysis
Looking at the organisations past and present activities and resources:
Products;
Organisation structure;
Systems and processes;
Marketing;
Distribution;
Finance;
Research and development;
Use of new technology.
This analysis should reveal the organisations internal strengths and weaknesses.
2.5 Setting objectives
Having analysed the external environment, the management will then clarify the objectives
of the organisation.
It is common for objectives to be given a hierarchy. Higher level objectives, such as the
Mission Statement, are broad statements which deal with the overall aims of the
organisation. Moving down the hierarchy, the objectives become more specific.

Mission
Main
Supporting

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2.5.1 Main objectives
These can be mission statements or statements of intent to particular stakeholders (e.g.
shareholders or employees).
2.5.2 Supporting objectives
These convert the main objectives into a series of targets for the business. These typically
include profit or sales targets for immediate implementation. Sub-objectives can be passed
further and further down the organisation resulting in short-term objectives for particular
departments, such as reducing costs by a given percentage or signing up a particular level of
customers each month.
Illustration 1

Mission statement To increase the wealth of shareholders by maintaining our
position as the leading provider in the industry.
Main objectives to maintain the satisfaction of all customers.
Specific objectives customer returns must account for less than 2% by value
of products sold.

This hierarchy of objectives is sometimes referred to as the performance hierarchy and is
discussed in more detail in Session 8.
2.6 Gap analysis
Gap analysis involves comparing the objectives of the business (where we would like to be)
with what the business is achieving at the moment. Gap analysis could for example focus on
the gap between desired and actual market share, desired or actual revenue, or desired or
actual profits.
Gap analysis is discussed in more detail in Session 8.
2.7 Selection of strategies
Management must make strategic choices. These determine how the organisation will go
about meeting its objectives.
2.7.2 Internal strategies
These focus on what the organisation needs to be good at internally to succeed. For
example, a low cost airline develops strategies to save costs, such as reducing parking time
at airports, and using lower cost airports.
2.7.3 Investment strategies
These look at the whole area of what to invest in. This may include decisions such as
whether to expand by buying up competitors (mergers and acquisitions) or to grow
organically. It also covers methods used for investment appraisal.
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2.7.4 Financing strategy
This looks at how to finance the organisation. Typical decisions include the appropriate mix
of equity and debt and dividend strategies. (Such strategies are covered in paper F9
Financial Management. )
2.8 Strategic control
Having set the corporate objectives, senior management will be involved in controlling the
organisation.
Definition

Control is the process of ensuring that a firms activities conform to its plan
and that its objectives are achieved.

Performance management focuses on designing systems for measuring the performance of
an organisation. Performance measures are developed, and progress is continually
monitored by comparing actual results against targets for the performance measures.
Performance measures are used at all levels of the organisation.
Strategic control involves ensuring that the organisation in on track to meet its long term
strategic objectives. A successful system of strategic control should therefore:
Focus attention on what matters in the long term.
Identify the drivers of success. Many businesses identify critical success factors, and use
key performance indicators to measure their progress in meeting these.
Include reward schemes that are based on achieving the critical success factors.
Definition

Critical success factors are the limited number of areas where things must go
right if the organisation is to flourish.

3 PLANNING AND CONTROL AT DIFFERENT LEVELS
3.1 Anthonys model
Robert Anthony described three levels of management within an organisation:
Strategic involved in setting goals and objectives for the organisation over the long
term.
Tactical management involved in management control. This means ensuring
resources are obtained and used effectively and efficiently in accomplishing the
objectives of the organisation.
Operational management ensuring that day to day tasks are carried out.
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Strategic
Tactical
Operational
Planning
info
Control
info

A comparison of the three levels of management is given below:
3.1.1 Strategic planning
Deciding which products or markets to be in.
Investment decisions.
Planning for environmental changes.
Identifying the competitive advantage of the organisation.
Longer term timescale could be years.
3.1.2 Tactical planning
Implementing the strategic decisions, often via a long term plan.
Preparation of annual budgets, and comparison of actual results with budgets on a
monthly basis.
Recruitment of staff.
Shorter time period for planning typically one year ahead.
Use of both internal and external information.
3.1.3 Operational planning
Routine planning (e.g. staff rotas).
Programmed decisions (e.g. ordering inventory when inventory levels fall to re-order
levels).
Based on internal, transaction based information.
3.1.4 Strategic control measures
Profits by business segment.
External factors influencing the organisation.
Present and potential market studies.
Investment appraisal.
3.1.5 Tactical control measures
Analysis of sales by product/customer/geographical location.
Inventory levels.
Cash flow projections.
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3.1.6 Operational control measures
Variances (e.g. materials and labour).
Receivables/payable levels.
Payroll details.
Customer complaints.
Output records.
Example 1

Vacation Lodge runs a chain of three star hotels throughout the world. The
companys head office is in New York, where the executive and non-executive
directors are based.
Each hotel has a management team headed by the general manager. The other
members of the management team are the financial controller, the rooms
division manager, the food and beverage manager, the sales and marketing
manager and the head of security.
Each hotel has an executive chef, responsible for the restaurants. The executive
chef reports to the food and beverage manager of the hotel.
Required:
Describe the types of plan that will be prepared by the directors, the
management teams and the executive chef. For each plan, describe control
measures which can be used to see how well the plan is being achieved.

Solution
Plans Controls
Board of directors

Management team

Executive chef

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4 MULTINATIONAL COMPANIES
4.1 Role of management accounting
Management accounting is used by multinational companies to coordinate and integrate
their activities in different countries. Such coordination normally takes place through the
systems of budgeting, performance measurement and currency management.
Issues of particular importance include the following:
Currency management the volatility of exchange rates makes measuring the
performance of the various parts of the organisation more complex.
Managing relationships with host governments over areas such as tax breaks and
subsidies. Many management accounting systems measure the performance of
managers of foreign operations based on after tax profits rather than pre-tax.
Transfer pricing may be used as a method of transferring profits from high tax to lower
tax states. This is covered in more detail in a later session.
4.2 Different types of multinational organisation
Porter suggests that multinationals may be classed into three types:
(1) The global firm an organisation that covers many different states, where the activities
carried out in each state are interdependent. For example, some components may be
made in one country, some in another, and final assembly may take place in yet another
country.
(2) The multidomestic firm is made up of a number of subsidiaries in different countries,
where the activities of one subsidiary are largely independent of others.
(3) Exporting firms tend to carry out most of their operations in the domestic market, and
sell into foreign markets via agents.
The differences in the approach to management accounting in the global firm and the
multidomestic firm can be summarised by the following table:
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Issue Global firm Multidomestic firm
Strategy To internationalise the value
chain
To balance risk through
portfolio management
Role of headquarters To develop and coordinate
subsidiaries in an integrated
effort. Coordination of
subsidiaries is strong.
To enhance the management
of financial resources.
Corporate coordination of
subsidiaries is weak.
Role of subsidiary To carry out and support a
detailed strategy developed
at headquarters.
To develop its own strategy
towards market and
production.
Role of budgeting To integrate activities across
subsidiaries with an
emphasis on products and
markets
To establish targets for each
individual subsidiary with
an emphasis on
accountability
Performance evaluation Many and diverse financial
and non-financial
performance measures
oriented towards products
and markets.
Relatively few, but
aggregated financial
performance measures
oriented towards individual
organisational entities.
Source: Management Accounting in Global Firms by Jan Mouritsen.

5 POTENTIAL CONFLICTS
5.1 Formal approach to strategic planning
The strategic planning model described above assumes a top down approach to strategic
planning, whereby a central board of directors sets the strategy, the rest of the organisation
is expected to achieve it. Where local decisions are being made by managers (e.g. in the case
of a decentralised organisation) there is a risk that the decisions made locally may not be
consistent with the strategy.
5.2 Reasons for conflict
There are several reasons why conflicts arise between strategic plans and short-term local
decisions:
Managers incentive schemes may not be aligned with the strategy of the organisation.
For example, managers bonuses may depend on the current years profits which could
be increased at the expense of longer-term strategic objectives, such as quality.
Local managers may have better knowledge of local opportunities than the directors
who set the strategy.
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Long term plans are prepared long before the period to which they apply. Actual
conditions may be quite different.
Local managers may feel that the formal strategic plan stifles their own creativity or
ideas it may not be flexible enough to allow unplanned opportunities to be adopted.
5.3 Potential solutions to the conflict
A parenting style may provide the solution to the conflict between strategic planning and
local decision making. Under such an approach, business units may formulate their own
strategies, while head office may set broader targets for the business units to achieve.
6 SWOT ANALYSIS
6.1 Internal and external analysis
In the corporate planning model described in section 2 above, one of the first things the
management do when planning is to perform analysis of the internal and external
environment. One tool which is commonly used for such an exercise is SWOT analysis.

Definition

SWOT analysis is a critical assessment of an organisations Strengths and
Weaknesses (identified from internal analysis) and Opportunities and Threats
(identified from external analysis) in order to establish its condition prior to the
preparation of any long-term plans.

By identifying the companys strengths and weaknesses during the planning process,
management can ensure that they plan to focus on performing those activities which the
company is good at, while avoiding those areas where the company lacks the relevant
skills or resources to compete effectively.
Opportunities represent business opportunities that the company may wish to exploit,
provided that it has the relevant skills. Thus it attempts to match the companys
strengths with the opportunities available.
Threats represent threats from outside. This could include a variety of things
competitors, new government regulations which threaten the industry, changes in social
attitudes and so on.
Swot analysis is often performed using a table with four quadrants. The strengths,
weaknesses, opportunities and threats are then listed in the appropriate quadrants.
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Example 2

Brilliant Airlines is the national airline of a small country in the European
Union. It is one of the oldest and most respected airlines in the world.
The company is based at Schiphoven airport; one of the busiest airports in the
world. This, coupled with alliances that the company has made with other
airlines, means that the airline can take advantage of passengers from other
less well connected airports, which connect at Schiphoven for longer flights.
Recently the company has been suffering stiff competition on certain routes
from low cost airlines, who offer a no frills service. Due to their lower cost
base, these low cost airlines are able to offer passengers much lower fares than
Brilliant Airlines charges.
The European Union is now introducing a tax on fuel in an attempt to reduce
the impact of greenhouse gasses caused by airlines. This will significantly
increase the costs of the airline.
Required:
Based on the information provided above, perform a SWOT analysis on
Brilliant Airlines, and suggest any opportunities that the airline may focus on.

Solution

Strengths

Weaknesses

Opportunities

Threats

6.2 Benefits of SWOT analysis
The focus on internal strengths and weaknesses ensures that strategic decisions are
taken which are appropriate for the organisation.
It focuses the attention of management on external factors (threats and opportunities).
Thus management can plan how to deal with changes, such as a decline in the market.
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7 BENCHMARKING
7.1 Problems with internally set standards
One of the core tools of traditional management accounting is variance analysis, which
involves the setting of a standard cost. One potential problem with this is that setting the
standard normally involves considering what was used in earlier periods and not
considering what other organisations are achieving so the standards set are not
challenging enough.
Benchmarking is a tool which involves comparison of the performance of an organisation
against other organisations. The focus is therefore external.
Definition

Benchmarking (also best practice benchmarking or process benchmarking)
is a process used in management and particularly strategic management, in
which organizations evaluate various aspects of their processes in relation to
best practice, usually within their own sector. This then allows organizations
to develop plans on how to adopt such best practice, usually with the aim of
increasing some aspect of performance.

7.2 Types of benchmarking
Competitive benchmarking comparing performance with competitors. Can be
difficult to obtain information about competitors however.
Commentary

This was pioneered by Xerox when Japanese competitors sold copiers into US at less
than Xeroxs manufacturing cost costing Xerox half their market share.

Internal benchmarking comparing one operating unit or function with another within
the same organisation in order to establish best practice.
Process benchmarking focusing on qualitative information around specific business
processes.
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7.3 Stages
(1) Planning and organisation (e.g. setting up a steering group and setting out aims and
objectives).
(2) Identification of key internal processes for analysis:

Practices steps in a process;
Metrics measures of times and outcomes (e.g. cost, quality, speed, reliability).
(3) Researching potential partners (those perceived to be the best). Collecting information
and investigating metrics for comparison.
(4) Making agreements and developing plans for exchange visits. Formulating a common
program for internal data collection and its presentation and analysis.
(5) Partner site visits by benchmarking teams collect dataand ensure comparability.
(6) Analysing data and developing plans for improvements.
(7) Implementation and monitoring.
Illustration 2

An organisation wishes to benchmark the effectiveness of its finance function.
It may identify the following metrics that it wishes to use. These would then
be compared against industry best practice:
Cost of finance function as a percentage of revenue;
Cycle time time taken (days) to perform annual close;
Staff productivity (e.g. number of invoices processed per member of staff);
Error rate (e.g. percentage of payroll processing errors).

7.4 Benefits of benchmarking
Provides focus for change within an organisation.
Identifies opportunities for improvement.
Helps to establish best practice.
Should lead to long term improvement in profits.
7.5 Difficulties of benchmarking
Competitors will not wish to share information.
Complexity of the information collected too much data can be difficult to interpret.
Short term improvements may have unintended longer term consequences.
Quantitative information provided may miss important qualitative.
The time taken to implement the results of benchmarking may mean that the
organisation continues to lag behind the competitor.
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Key points

Strategic management accounting is a broad term, encompassing an
approach to management accounting that is more externally focused, to
assist management in formulating and implementing strategy.
Strategic planning may follow the modern approach which involves
analysing the organisations strengths and weaknesses, and then clarifying
the objectives of the organisation, before deciding on the strategic actions
required.
Strategic control means monitoring the performance of the organisation to
ensure that it will meet its long term strategic objectives.
Organisational planning takes place at different levels. Anthonys model
defines three levels of planning Strategic, Tactical and Operational.
Strategic management accounting is more challenging in multinational
organisations. The objectives of control differ depending on the
organisational structure of the multinational.
There is always scope for conflict between strategic plans developed by
the board of directors and the short term decisions made by local
managers. Organisations should identify ways to remove this conflict,
such as adopting a parenting style.
SWOT analysis is a useful tool in developing the objectives of an
organisation.
Benchmarking provides organisations with a more external focus when
setting standards of performance.

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FOCUS
You should now be able to:

explain the role of strategic performance management in strategic planning and control;
discuss the role of corporate planning in clarifying corporate objectives, making
strategic decisions and checking progress towards the objectives;
compare planning and control between the strategic and operational levels within a
business entity;
assess the use of strategic management accounting in the context of multinational
companies;
discuss the scope for potential conflict between strategic business plans and short term
localised decisions;
evaluate how SWOT analysis may assist in the performance management process;
evaluate the methods of benchmarking performance.

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EXAMPLE SOLUTIONS
Solution 1 Planning and control
The following is not an exhaustive list of the plans and controls any other reasonable plans
and controls are also relevant.
Plans Controls
Board of directors Five year financial plan Actual profits v plan
New hotel openings monitoring progress

Management team Annual budget Compare actual against budget
Occupancy rates
Staff Headcount Actual v plan

Executive chef Menus Food wasted
Staff rotas Staff attendance

Solution 2 SWOT analysis for Brilliant Airlines
Strengths
The National Airline flag carrier
Good reputation particularly among
business passengers
Good location at major Airport
Alliances with other airlines
Weaknesses
Higher cost base

Opportunities
Focus on business passengers less
price sensitive

Threats
Competition from low cost airlines
Additional fuel taxes

Commentary

Questions such as these are judgemental by nature; there is no single right answer
(particularly as regards to the opportunities). In the exam, the examiner awards marks
for sensible suggestions.

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SESSION 02 PERFORMANCE MANAGEMENT AND CONTROL OF THE ORGANISATION
OVERVIEW
Objective
To appraise alternative methods for budgeting for control.

Criticisms of traditional budgeting
Beyond Budgeting Model
BUDGETING IN
NOT-FOR-PROFIT
ORGANISATIONS
Top down v bottom up
Fixed v flexible
Rolling budgets
Incremental budgeting
Zero based budgeting (ZBB)
Activity based budgeting (ABB)
How budgeting may differ
Traditional approach
Planning, programming budgeting
systems (PPBS)
ALTERNATIVE
BUDGETING
MODELS
BEYOND
BUDGETING

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1 ALTERNATIVE BUDGETING MODELS
1.1 Top down v bottom up budgeting
Top down budgeting is where budgets are prepared centrally, usually by senior
management. These are then imposed on more junior managers.
Bottom up budgeting means that managers prepare their own budgets initially. These are
then reviewed by the finance department some negotiation may take place before the final
budget is achieved.
Example 1

State the advantages of top down budgeting and the advantages of bottom up
budgeting.

1.1.1 McGregors theories of human behaviour
McGregor suggests that the circumstances in which top down or bottom up budgeting
would be more appropriate depends on the nature of the employees. The two types of
employees are the Theory X and Theory Y employees:
Theory X
people dislike work;
people dislike responsibility;
they are only motivated by money;
they must be told what to do.
Theory Y
people seek responsibility;
they want to participate in decision making.

The type of employee working for an organisation therefore has implications for the
budgetary process.
Employee type X Y

Motivated by Money Many factors

Does participation
increase motivation? No Yes

Management style Authoritarian Participative
approach approach

Budgeting style TOP DOWN BOTTOM UP

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Features Senior management prepare
budgets;
Imposed on junior
management;
Quicker than bottom up
approach.
Junior management prepare
budgets;
Senior management review to
ensure consistent with
organisation objectives;
But risk of budget bias/slack.

1.2 Fixed v flexible budgets
At the end of the period, actual results are compared to the budget, and action taken to
remedy any deviations from the budget in future periods. The problem arises that if the
budget is prepared at one activity level, and the actual activity is very different, then the
comparison becomes less meaningful, as it is difficult to see what deviations from the
budget are due to the different level of activity, and what deviations are due to other factors.
The first three approaches to budgeting relate to how the budgets are adjusted to take
account of actual activity levels prior to the comparison of budgeted and actual amounts.
1.2.1 Fixed budgets
A fixed budget is prepared at the beginning of the period based on the expected activity
level (sales units, production units etc.) No adjustment is made to this budget at the end of
the year when comparing actual performance against the budget. This means that the
budgeted activity levels may be very different from the actual activity levels, making
comparison difficult.

1.2.2 Flexible budgets
When the budget is prepared, several versions of the budget are prepared. So a budget may
be prepared, for example, for 12,000, 14,000 and 16,000 units. At the end of the year the
budget that is closest to the actual activity level is used for the comparison of actual results
against the budget.
Such an approach requires knowledge of cost behaviour which costs are fixed, so will not
vary with output, and which are variable.
1.2.3 Flexed budgets
At the end of the year, prior to comparing the actual figures against the budget, the budget
is recalculated (flexed) using the original budget assumptions, but the actual activity levels.
This means that the comparison is more valid.

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Illustration 1

Original budget
$000 $000
Sales (50,000 items @ $100) 5,000

Production (55,000 units)
Materials (55,000 40) 2,200
Labour (55,000 3) 165
Variable overheads (55,000 x 9) 495
Fixed overheads (55,000 x 15) 825

_____

Budgeted cost of production 3,685

Less: Closing inventory (5,000 @ $67) (335)

_____

Standard cost of goods sold 3,350

_____

Budgeted profit (50,000 @ $33) 1,650

_____

Actual sales were 53,000 units and production was 56,000 units. The flexed budget
would be calculated as follows:
Flexed budget
$000 $000
Sales 53,000 $100 5,300

Production costs
Materials 56,000 $40 2,240
Labour 56,000 $3 168
Variable overheads 56,000 $9 504
Fixed overheads 825
Less: Closing inventory (201)

______

Cost of goods sold 3,536

______

Profit 1,764

______

1.2.4 Advantages of flexed and flexible budgets
Easier comparison of actual results against the budget since like is being compared with
like.
During the planning stage, management has better knowledge of cost behaviour, and
therefore what impact changes in output will have on total costs.
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1.2.5 Disadvantages of flexed and flexible budgets
In the modern business world, many costs are fixed so flexible and flexed budgets
may add little value.
Difficulty of identifying variable and fixed costs.
Example 2

Good Trip is a travel agency. It employs a team of five staff an accountant,
three sales staff and a manager. The agency does not organise holidays
directly, but acts as agent for big package holiday companies. The company
receives a commission on each booking that is made.
Required:
Discuss whether fixed or flexible budgeting would be more appropriate for
Good Trip.

1.3 Rolling budgets (Rolling forecasts)
1.3.1 Weaknesses of traditional periodic budgeting
Traditional periodic budgets are prepared in advance for the full budget period
(typically one year). The problem with this approach is that the budget itself may
become outdated very quickly due to changes in the external environment.
In response to this weakness, many organisations prefer to use rolling budgets.
Definition

A rolling budget is a system of budgeting where the budget is continuously
updated. The budget horizon (typically one year) is kept constant by adding
another month (or quarter) to the end of the budgeted period as each month
(or quarter) expires.

Illustration 2

A budget is prepared for the year 2010.
At the end of January 2010, the actual performance for the month of January is
compared against the budget. Based on this comparison, it may be decided
that the budgets for the period 1 Feb to 31 Dec 2010 should be changed to
reflect changes in external factors. Once this has been done, a budget is also
prepared for January 2011. The new budget therefore covers the period from 1
February 2010 to 31 January 2011.

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1.3.2 Advantages of rolling budgets
The budget is always updated to reflect external changes. It is therefore more relevant
and more valid for comparison against actual performance.
There will always be a budget for the next 12 months. This can be useful for planning
things such as cash flows.
Managers will be more motivated as the budget is more realistic, since it will be
updated to take account of changes that occur that are outside of their control.
1.3.3 Disadvantages of rolling budgets
Time consuming.
Budgets may be changed to hide operational inefficiencies.
Not necessary in a stable environment.
Example 3

Betterbuys is a food retailer that runs a supermarket in northern England. Pear
develops portable communication devices and music players to the top layer of
the market. Pears products have short lifecycle due to the competitive nature
of the market.
Required:
Discuss whether rolling budgets would be appropriate for each of the two
organisations.

1.4 Incremental budgeting
Starts with previous periods budget or actual results.
Add/subtract an incremental amount to cover:
Any known changes to the business;
Inflation.
Only the increment needs to be justified.
May be appropriate for stable business with good cost control.
1.4.1 Advantages of incremental budgeting
Easy and quick to prepare the budgets.
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1.4.2 Disadvantages of incremental budgeting
Unnecessary costs will remain in the budget because they were in the previous years
budget. Inefficiencies will therefore be compounded.
Does not encourage a detailed examination of where efficiencies can be identified.
Budgeted expenditure is not related to the activities that the organisation wishes to
perform.
1.5 Zero based budgeting (ZBB)
Commentary

This was developed in 1960s by Federal Government managers in the US.

1.5.1 Basic features
Zero based budgeting is an attempt to overcome the weaknesses in incremental budgeting
in particular, the criticism that costs will be included in a budget because they were in
previous years budgets. Zero based budgeting requires managers to plan what projects
they wish to do, and base the budget around these.
Starts with assumption that the budget for next period is zero.
Budget holders identify what programmes their department wishes to perform in the
next year.
Budget holders prepare a decision package for each program which includes:
Goal of the programme;
Level of funding required and benefits;
Consequences to the company of the department not performing its function.
Senior management (usually a budget committee) decide which decision packages to
accept based on predetermined criteria.
Resources allocated to departments according to ranking.
1.5.2 Advantages of zero based budgeting
Should reduce budgetary slack as costs must be justified based on the activities they
relate to.
Useful for discretionary spending and support activities such as advertising and
research and development where management can choose how much to spend on a
particular item.
Resources will be allocated to the programmes that best achieve the objectives of the
organisation.
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1.5.3 Disadvantages of zero based budgeting
Too costly and time consuming this is why it has never achieved the popularity that
its proponents expected.
Not appropriate for non-discretionary expenditure such as costs of production as these
depend on quantities of output.
Budget holders, staff and unions may feel threatened that they have to justify their
existence.
The ranking and selection of packages may be subjective.
Commentary

Many organisations have used a partial version of zero based budgeting where zero
based budgeting is used in some departments that do discretionary type activities, such
as marketing, but not used throughout the organisations. Other organisations have
used zero based budgeting as a one off exercise to identify potential cost savings
before returning to more traditional incremental types of budgeting in future periods.

1.6 Activity based budgeting (ABB)
1.6.1 Principles of activity based budgeting
Activity based costing (ABC) is assumed knowledge from paper F5 Performance Management.
Activity based budgeting follows the principles of ABC in reverse. Having decided how
many units to produce and sell, the organisation then needs to define the cost of the
activities required to produce them. These depend on the drivers identified for each
activity. A typical activity based budgeting exercise may follow the following steps:
(1) Estimate the expected output (units) for each product.
(2) Identify the number of units of each activity that will be required to produce the output.
This is based on knowledge of the relationships between the output and the activities
that are required to be performed to product the output.
(3) Determine the resources needed to perform the activities required. This is based on
knowledge of the drivers the factors that influence the price of the activities.
(4) If the current commitment of resources is such that too many or too few resources exist
to perform the activities required in 3, then adjust accordingly.
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Illustration 3

Alex uses activity based costing, and wishes to adopt an activity based
approach to budgeting.
Having estimated the total budgeted sales for the next financial year (Step 1
above), Alex has identified that one of the activities needed for to support the
budgeted sales is Processing sales orders. Alex has identified that 2,800
orders will be received next year (Step 2).
One of the resources needed for processing orders is staff. Each member of
staff in the Sales Order department can handle 60 orders per month, or 720
order per year. Since Alex expects 2,800 orders next year, the company will
need 3.88, or four members of staff. (Step 3).
Currently Alex employs six members of staff in the Sales Order Processing
department. Alex should consider relocating two members of staff to other
departments.

Activity based budgets are performed by repeating the steps above for all activities in an
organisation and preparing a total budget. Organisations often use a matrix approach to
such budgets, with a column for each activity, and a line for each type of expenditure.
Example 4

Identify the advantages and disadvantages of using activity based budgeting.

Solution

2 BUDGETING IN NOT-FOR-PROFIT ORGANISATIONS
Definition

Not for profit organisations are distinguished from profit maximising
organisations by three characteristics. First, most do not have external
shareholders providing risk capital. Second, they do not distribute dividends,
so any surplus that is generated is retained as a further source of capital.
Third, their objectives usually include some cultural, philanthropic or
environmental dimension which in their absence would not be provided
through the market system.
(Extract from the article Not for profit organisations by Robert Souster in
Student Accountant, September 2009.)

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2.1 How budgeting may differ in non-profit organisations
2.1.1 The public sector
The public sector includes organisations such as schools and hospitals, and government
departments. Budgeting in such organisations may differ from budgeting in the commercial
sector due to the following factors:
Budgeted income for the organisation is determined by political objectives and may
therefore be determined outside of the organisation.
Public sector budgets tend to be based on incremental methods of budgeting, with
annual negotiation only of marginal expenditure. Thus the budgeting process may not
really be a detailed examination of required expenditure.
Public sector departments may have to compete with other departments for funds from
central government. Achieving more funds for a department may be seen as a sign of
strength of the minister involved in running that department thus there is little
incentive to reduce spending within departments or to look for efficiencies as this may
be seen as a sign of weakness.
If actual spending is below budget, then the resources allocated to that body may be
reduced in the future. This means managers have an incentive to ensure that they
spend the budget rather than try to beat it.
Budgets in the public sector are a means of control, and are likely to be top down with
managers having little participation in their preparation.
The size of public sector bodies and their structured chain of command makes it
unlikely that new approaches to budgeting, such as the beyond budgeting model
(covered later) would be feasible in the public sector as these require devolution of
planning away from the centre to lower levels of management.
Other regulations may also apply to public sector bodies. For example, if one
department under spends, it may not be allowed to transfer the surplus to another
department within the organisation.
2.1.2 Other non-profit organisations
The following are some of the factors that make budgeting in all non-profit organisations
different to commercial organisations. These may apply to public as well as private sector
bodies:
Non-profit organisations are expected to perform their function within the funds
provided. In practice, the funds may not be related to the amount of services provided.
For example, the emergency department in a hospital will treat all casualties. The funds
provided to this ward may not vary with the number of casualties. Thus these bodies
have to provide the best possible service with the limited funds available.
The funds required to finance not for profit organisation may come from charitable
donations. At the time of preparing the budgets, the amount of funding to be received
may be unknown.
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Budgeting in not for profit organisations focuses therefore on costs allocating the
limited funds of the organisation to the required activities, and performing these
activities within the budget.
2.2 Traditional approach to budgeting in not for profit organisations
The traditional approach used was to use Line item budgets. A line item budget
focuses on the expenses of an organisation in detail, with little attention given to the
activities that the organisation is performing.
Illustration 4

A typical line item budget is presented below:
2009 Actual 2010 Budget 2011 Budget
$m $m $m
Employment costs 1,250 1,300 1,400
Building maintenance 500 505 515
Supplies and services 700 770 800
Establishment expenses 125 130 140
Financing expenses 10 11 12
Other costs 15 17 20
_____ _____ _____
2,600 2,733 2,887

_____ _____ _____

2.2.1 Disadvantages of line item budgets
They do not relate the expenditure of the organisation to the activities it performs.
Budget expenditure is usually based on previous actual historic cost. The budget does
not therefore ensure that the funds are being used efficiently nor effectively.
They do not provide a basis of allocating the limited funds of the organisation to the
activities it performs.
2.3 Planning, programming budgeting systems (PPBS)
2.3.1 The principle
Planning, programming budgeting systems have been adopted by some non-profit
organisations as a way of overcoming the weaknesses of line item budgets. It is a method of
budgeting, similar to zero based budgeting, in which the funds of the organisation are
allocated to particular programs.
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The steps in performing PPBS might be as follows:

Thus the PPBS is a long-term method of planning and budgeting, as it involves
establishing the objectives of the organisation.
Programs are likely to be the major activities undertaken by an organisation. For a local
government, for example, programs may include providing primary education or old-
age health care.
The budgeted costs will be based on programs rather than line items. These may cut
across departments, if several departments are involved in programs, so the budget
may not mirror the organisational structure. A possible solution to this may be to use a
matrix structure, with one manager responsible for each program.
Program budgets may extend beyond one financial year.
2.3.2 Advantages of PPBS
Forces management to allocate resources more appropriately.
Provides useful information for performance measurement, when looking at the value
for money of a service
2.3.3 Disadvantages of PPBS
Practical difficulties of applying the system.
Identifying information on the success of the program.
Establish the overall objectives of the
organisation
Identify potential programs to meet
these objectives
Establish the costs and benefits of the
various programs
Decide how much funds to allocate
to each program
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Example 5

Identify some of the objectives of the local government in the area where you
live. Having identified these objectives, take one objective, and suggest some
programs that the local government could organise to help achieve these
objectives.

Solution

3 BEYOND BUDGETING
3.1 Criticisms of traditional budgeting
In recent years there has been much criticism of the traditional budgetary processes. Hope
and Fraser detail these criticisms in their book Beyond Budgeting. This looks at the
problems inherent in the traditional budgeting process, and suggests an alternative
approach to performance management, the Beyond Budgeting model.
In discussing budgets, Hope and Fraser use a broader definition of budgeting than simply
producing a financial plan. They mean the whole performance measurement process of
agreeing on the targets, setting reward schemes based on achieving those targets, using
budgets to allocate resources, and controlling performance based on this process. They refer
to this as the fixed performance contract.
The main criticisms of this budgeting model as described by Hope and Fraser are as follows:
3.1.1 Budgets take up too much time
The budgeting process takes up too much of the time of senior management, and does
not add sufficient value to the organisation to justify this.
The annual budget process takes up to 20% to 30% of senior management time;
Accounting staff do not have sufficient time to work on value added activities;
Managers have to wait 11 days into the following month before they see
comparison of their actual performance against the budget for the previous month.
3.1.2 Budgeting is out of kilter with the modern business environment
In the older more stable business climates that existed prior to the 1970s, management
processes emphasised the need for reasonable return on capital targets. Using budgets
was a good way to ensure tight cost control to achieve required return on capital.
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In the more competitive environments that have existed since the 1980s, businesses
must react quickly to customer needs. This requires transferring power from the centre
to managers who are closer to the customers. The old command and control structure
of organisations represented by traditional budgeting process has become outdated.
The primary drivers of shareholder value in the modern business world are intellectual
capital such as brands, loyal customers and proven management teams. These are
outside of the orbit of the budgetary control system.
3.1.3 The extent of gaming
Budgets were initially introduced as a planning tool for managing costs and cash flows.
However, over time budgets also came to be used as performance management tools for
managing the business. The fixed performance contract was introduced, as follows:
A fixed target usually expressed in terms of budgeted sales, costs, profits and ratios
such as return on capital employed.
Incentives were introduced based on achieving these targets, such as bonuses and
promotions for achieving the budgets.
Resources are allocated to departments based on the budget.
This system sounds good in theory, but in practice it can lead to an annual performance
trap whereby the actions of all managers are focussed on meeting the performance targets
of the current year.
This may lead to dysfunctional behaviour, or gaming. Gaming means manipulating a
system to achieve some advantage. During their research, Hope and Fraser encountered the
following examples of gaming:
Managers always negotiate the lowest targets and the highest rewards.
Always make the bonus whatever it takes (e.g. by window dressing).
Commentary

For example, ensuring that sales targets are met by making sales on a sale or return
basis at the end of the financial year to a friend. The following year the goods are
returned.

Never put the customer above the sales targets.
Never share knowledge or resources with other teams.
Always ask for more resources than you need. You will be cut back to what you
actually need.
Always spend whats in the budget or you will lose it.
Always have the ability to explain adverse variances blaming them on causes beyond
your control.
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Never provide accurate forecasts hide bad news or you will be expected to
compensate
Always meet the numbers, never beat them.
Never take risks.
3.2 Beyond Budgeting Model
Hope and Fraser suggest that the traditional budgetary control process should be replaced
by the following system:
Replace financial targets with targets based on key performance indicators, such as
return on capital employed, which are based on the companys main objective.
Appraise managers based on how they perform relative to peers, benchmarks or prior
years, rather than against fixed targets. This reduces incentives for gaming, since the
fixed target no longer exists.
Devolve responsibility for planning away from the centre. Managers on the front line
have better knowledge of what is going on.
Make resources available if new opportunities arise, even if they are not in the original
budget.
Use rolling forecasts, performance league tables, and other key performance indicators
to measure and control performance rather than just relying on comparison of actual
performance against the budget.
Example 6

Explain how each of the suggestions in the beyond budgeting model will help
to overcome the problems with traditional budgeting.

Solution
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Example 7 Case Study

Moto manufactures plastic components which are supplied to a large number
of users in the electrical products sector. The firm has a reputation for high
quality products and the business has grown significantly over the last five
years. The market is very competitive and much of the success has been due to
flexibility and the development of an experienced cohesive management team.
Last year a new managing director was appointed. His main task was to
increase profitability over a three year period in anticipation of a public
flotation. This resulted in the implementation of new management policies
designed to improve efficiency and accountability. These included:
(1) Responsibility accounting systems based on a matrix structure integrating
production departments and functional management.
(2) The formation of an executive budget committee to set all departmental
and manager budgets. The committee comprised functional directors, the
chief accountant and the managing director.
(3) Monthly reporting systems for all budgetees based on conventional full-
cost variance analysis and profit-based sales analysis.
(4) A bonus system for all production department supervisors and functional
managers based on achievement of monthly budgets.
Results during the first six months of the new policies did improve but more
recently performance has not been impressive and managers have begun to
notice a change in the organisational climate. The product range has been
rationalised and much of the highly-skilled special work has been dropped.
The stringent budget requirements have put considerable pressure on
departmental and functional heads that now see much less of each other
despite the interdependence between them. The enthusiasm for the new
management systems has now been transformed into a fear of monthly results,
fuelled by recent demotions and appointments from outside.
The following were typical of managerial reaction after the latest monthly
results:
Last months budgets were impossible. My department operated at its most
efficient level for months and I still didnt make the target.
What I cant understand is why the published budgets look nothing like our
own submitted estimates.
My results totally ignore the breakdown in my main supplying department.
I may have made my budget but I wouldnt like to guarantee either the
quality of the output or the accuracy of the output figures.
The only response I got to last months performance was no bonus and a
nasty memo.
Required:
Critically evaluate the situation at Moto, making full use of the information
available.

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Key points

Various budgetary systems exist for comparing budgeted performance
against actual, where the level of activity is not the same as envisaged in
the original budget. The methods are fixed, flexible, flexed, periodic and
rolling.
Incremental budgeting is used traditionally this is where the current
years budget is used as a starting point in preparing the next years
budget. Zero based budgeting tries to improve on this by starting the
budgeting process with a zero base, and basing the budget on the activities
that the organisation wishes to perform.
Budgeting in not for profit organisations focuses on achieving the
organisations objectives as efficiently as possible. A model that is used by
many such organisations is the planning, programming budget system
(PPBS) in which the organisation allocates its limited resources to
programs which achieve the objectives of the organisation most efficiently.
Hope and Fraser criticise the traditional budgeting system. They believe
that it is too time consuming, it does not align the interest of managers and
the organisation, and that the extent of gaming has made the budget
process a mockery.
The Hope and Fraser Beyond Budgeting model proposes the following:
Replace financial targets with targets based on the key objectives of
the organisation.
Replace fixed targets with relative targets, based on how managers
perform relative to peers.
Devolve responsibility for planning away from the centre.
Make resources available for projects that meet the objectives of the
organisation even if they were not in the original budget.
Replace fixed targets with rolling forecasts.

FOCUS
You should now be able to:

evaluate the strengths and weaknesses of alternative budgeting models and compare
such techniques as fixed and flexible, rolling, activity based and incremental;
assess how budgeting may differ in not for profit organisations from profit seeking
organisations;
evaluate the impact to an organisation of a move beyond budgeting.
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EXAMPLE SOLUTIONS
Solution 1 Top down v Bottom up budgeting
Advantages of top down
The budgets prepared are likely to be consistent with the longer term objectives of the
organisation.
Interdependencies of the various departments will have been taken into account the
budgets of all departments will be coordinated.
The budget will not be manipulated by the managers who are responsible for achieving
it (e.g. by adding budgetary slack).
Advantages of bottom up
Managers will be more motivated to achieve the budget if they have been involved in its
preparation.
Managers have better knowledge of the conditions that they face than senior
management, so will know what is more realistic in terms of targets.
Solution 2 Fixed versus flexible budgeting
It is likely that most of the costs of the travel agency are fixed. The salaries of the staff are
likely to be a major cost, as is the rental of the premises. These costs would not vary with the
volume of business. Little benefit would therefore be gained from flexible or flexed
budgeting, at least in terms of comparison of costs.
Regarding revenue, this is commission based. The prices of the holidays, and therefore the
commissions that Good Trip earns on each holiday are likely to be set by the industry, so
there would be little difference between the budgeted and actual price per unit. Flexing the
budget would simply adjust the sales volume to actual again providing little additional
useful information.
Fixed budgeting would therefore be more appropriate to Good Trip.
Flexible and flexed budgeting are more useful in situations where there are a high degree of
variable costs.
Solution 3 Rolling forecasts
In the case of Betterbuys, the environment within which it operates is liable to be more
stable. Demand for food is likely to remain fairly constant, regardless of the state of the
economy. As such, there is likely to be less need to constantly update the budget, and a
fixed budget would suffice.
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One advantage of rolling budgets is always having a fixed (normally 12 month) time horizon
in the budget. In the case of Betterbuys, there may be advantages to having this extended
time horizon but it is unlikely that the benefits would exceed the additional costs and time
required for preparing rolling budgets.
Pear by contrast is in an industry that is continually changing. Products have short life
cycles, and demand for the companys products is likely to be very uncertain and difficult to
forecast accurately. It is in such situations that rolling forecasts become useful, as the
budgets can be continually updated to take into account the uncertain environment.
Solution 4 Activity Based Budgeting
Advantages of Activity Based Budgeting
Management attention is focussed on the activities of the organisation. These are
something that management can control more easily than focussing on total costs.
Better understanding of what causes costs to be incurred may provide opportunities for
cost reductions.
May identify non-value added activities which can be estimated.
Disadvantages of Activity Based Budgeting
Complicated and expensive to implement. More suited to large organisations with
multiple products and many drivers.
Many fixed costs do not vary with changes in the volume of drivers in the short run so
Activity based budgeting may provide misleading information.
Solution 5
Commentary

Clearly this is a very open question, and the solution provided here is just an
illustration of one possible solution to this question.

Objectives of a local government
To provide:
public transport services;
education for children;
health care;
cultural activities;
sporting facilities;
parks and other leisure facilities.
To promote tourism and attracting tourists to the area.
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Potential programs to attract tourists
An advertising campaign.
Provision of tourist information facilities within the area.
Supporting museums and galleries financially.
Providing signs in other languages for tourists.
Performing quality checks on local hotels and restaurants.
Solution 6 How the Beyond Budgeting Model Helps
Replacing financial targets with performance indicators based on the objectives of the
organisation. This will align the objectives of the managers whose performance is being
measured with the objectives of the organisation. This is likely to overcome the problem of
always meet the financial target whatever it takes which can result in managers taking a
short term view, or ignoring other non-financial factors.
Replacing absolute targets with relative targets should reduce the need of managers to
manipulate data to meet their performance targets. Sales managers, for example, will not be
trying to hit absolute sales figures, but markets share or similar targets. If the market falls,
so will their target, making it less likely that they will fail to achieve the target.
Devolving planning away from the centre managers will prepare their own targets. This is
likely to mean that the plans are more realistic managers will see the plan for what it is a
plan to help them to manage their section of the business better, rather than a tool to try to
constrain them.
The use of rolling budgets should overcome the criticism that traditional budgets become
meaningless and are not therefore a useful tool.
Solution 7 Case Study
Commentary

The solution which follows is very detailed. It is unlikely that you would have made
such a detailed solution nor would you be expected to. The purpose of the solution is
to help you to understand in more depth some of the issues that were covered in the
theory above, and how they relate to a real life example.

The problems raised in the case study
The problems raised fall into a number of areas:
External Not competing as efficiently;
Loss of product quality.
Internal Worsening results;
Poor morale and motivation.
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A more detailed analysis of the problems is as follows:
1 Lack of participation in budget-setting and performance appraisal.
2 Performance measures ignoring interdependencies and uncontrollable factors.
3 Too much budgetary pressure linked to high performance targets.
All of these problems are occurring during the period of organisational change and the
current results indicate a mismanagement of the change. The organisation is now resisting
the enforced changes and this is at least partially a failure of the management of the
budgetary control system. The price is being paid for the short-run gains.
The management system introduced in recent times has taken on several of the
characteristics of a scientific management approach. These include the following.
(a) Top Down budgeting;
(b) Linking budget performance to economic rewards;
(c) Adopting a very short-run view of performance;
(d) Setting budgets which are too difficult;
(e) Ignoring report formats;
(f) A generally authoritarian management style.
This change of management system appears not to have improved organisational
effectiveness. The reasons include the following.
(a) Disruption of traditional customer servicing and product specialisation;
(b) Exclusion of non-economic rewards;
(c) Disintegration of existing management groupings.
Importantly, Moto was already a successful organisation.
Policies might have been more successful if some aspects of the participative model had been
considered. Of particular relevance would be the following.
(a) More consultation (e.g. bottom up budgeting);
(b) More supportive feedback;
(c) More words and less figures in reports to reflect the interdependencies;
(d) Extending reporting horizons one month is a very short period;
(e) Generally improving communications between managerial levels.
Stage III: Conclusions
The reactions of the managers clearly indicate attitude problems which are beginning to
affect motivation and performance. These consequences seem at least partially due to
the new management system and style, incorporating a very tight budgetary control
system. There is no one optimal management system to solve the problem, but Moto
must try to achieve a better match between its control systems and its organisational
situation.
One would conclude that this match could involve introducing
(a) More participation;
(b) More supportive feedback with full recognition of interdependencies;
(c) Removal of the bonus payment system;
(d) A change of attitude at the top regarding quality and job satisfaction.
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