Example 2:

A manufacturing company had the following STANDARD PRIME COSTS and STANDARD PRIME QUANTITIES budgeted to produce one unit of their main product:

Direct Materials: 25kgs at $15.00 per kg

Direct Labour: 0.5 hour at $40 per labour hour

Quantity produced: 1,500 Units of the product.

ACTUAL COSTS AND QUANTITIES FOR THE PERIOD:

Direct material purchased: 50,000 kgs at a TOTAL cost of $725,000

Direct material used: 38,250 kgs used in production

Direct labour: 735 hours at a TOTAL cost of $30,870

a) Use the standard cost variance formulas to compute the four PRIME COST STANDARD COST VARIANCES. Show all formulas, your workings and indicate whether each variance is favourable or unfavourable.

b) In the space provided below, describe TWO LIMITATIONS and TWO ADVANTAGES of the Standard Costing System in a modern manufacturing environment.

FINANCIAL PERFORMANCE MEASURES - WEEK 7

The Chilled Leisure Company (CLC) has decentralised the operation decision-making of its divisional units. The Chief Operating Manager for each of these business units is given a great deal of freedom in their decision making however, the company offers bonuses of up to 100% of their annual fixed salary for achieving high profit returns and at the same time, carefully managing the amount of capital they use in their divisions.

CLC uses traditional performance measures such as Return on Investment (ROI) or simple Profit measures. CLC's Chief Executive and Chairman believe profit-based measures are still the most important measure because that is what shareholders want.

The projections for 2019 for CLC's Hotels and Casino Resort Division (CRD) are as follows

Sales: $10 000 000

Profit:

24%

Average Invested Capital

$12 000 000

Required:

a) Calculate what the Return on Investment (ROI) for the Casino Resort Division will be for 2019?

The Board of CLC and the CEO have decided on a set of strategies with the goal of expanding their offering to regular guests by setting up a loyalty program. The extra costs of this loyalty program would include an additional $8,000,000 in software and setup (capital) costs and it is expected that this would generate an additional $5,000,000 in sales however profit margin (after running costs) would initially fall to 22%.

b) Calculate the new ROI if this new program was introduced.

c) Discuss how the manager may feel about this new innovation if the costs affected the ROI and therefore the bonus payable

d) If CLC went ahead with the new program and used Economic Value Add (EVA) to also balance and measure performance, would the manager be more or less in favour of the proposal?

EVA = NPAT - (Capital employed x WACC)

NPAT = PBT x (1-t)

Assume the trade creditors and 'free' credit would be $600,000, the tax rate is 30% and the Weighted Average Cost of Capital (WACC) was 11%. (Show calculations and give reasons for your answer.)

e) If the manager accepted the proposed reduced margin of 22% but wanted to negotiate with the CEO about the extent of the Loyalty Program (i.e. minimise proposed investment cost) to maintain an ROI of say 19%, what is the maximum amount of (average) invested capital that could be made and still achieve this goal?

ROI = PROFIT / INVESTED CAPITAL = 0.19 = $3,300,000/ Target Invested Capital = $17+m

f) If the CEO agreed with the manager's new investment target in e) calculate the EVA with these new amounts, using the same trade creditor, tax rate and WACC as shown in d) above.

NON-FINANCIAL PERFORMANCE MEASURES

Note that these are often known as 'Strategic Performance Measures' and the systems that include them are referred to in the text as SPMSs (Strategic Performance Measurement Systems). There is no suggestion that business should abandon Financial Performance Measures, (often known as Key Performance Indicators or KPIs), but rather adopt a 'balanced approach' to measuring financial performance with alternate measures.

Considering the strengths of Financial Performance Measures: (FPMs such as KPIs)

Consider the limitations of Financial Performance Measures: (FPMs such as KPIs)

Consider the advantages of using an SPMS (such as the Balanced Scorecard) rather than only (KPIs) to measure performance.

What is the KEY advantage of non-financial measures over only using financial measures?

Give THREE additional benefits of an SPMS such as the BSC over traditional measures of KPIs and explain what is meant by these advantages

1.

2.

3. Give at least TWO examples of LEAD indicators from the remuneration plan/policy of the company your group studied for the group assignment. Describe how these non-financial indicators were used to measure individual and group performance in that company.

Product Mix Tactical Decisions given a production constraint

A company produces three products as shown below. If there was a temporary limitation of available production hours (as shown), in which order should the company produce each product and in what quantities if it used purely financial means to schedule production. If this shortage was determined to be ongoing, how would the company's strategic decisions differ from this 'short term' approach; and what other considerations may have to be considered?

Machine hours limited to 3500 MHs