PAPER F5 : PERFORMANCE MANAGEMENT

(W2) Where activity based costs are used when charging out the service division
costs we have:
Service type Cost driver Service Division A Division B
costs costs
£m £m £m
Sales Customers 1.8 1.20 0.60
Advertising Product types 2.4 0.96 1.44
Production Batches 0.8 0.40 0.40
Administration Employees 2.0 1.60 0.40
_____ _____

Total 4.16 2.84

_____ _____

(W3) Total external sales value of the service is £6.5m. Where this is used as the
charge-out from the service division, it will report a net loss of £0.5m.
(b) The required return on capital employed for each division is 15%. Division A will
achieve this return where a 50/50 cost basis or an external supplier price basis is used.
It will not find the 50/50 cost plus profit mark-up or the ABC bases acceptable.
Division B will achieve the required 15% return where the 50/50 cost basis or the
ABC basis is used. It will not find the 50/50 cost plus profit mark-up or the external
supplier price acceptable.
The service division will only find the 50/50 cost plus profit mark-up basis
acceptable. This enables it to record a return of 15%. It will be unhappy with the cost
based approaches which result in it reporting a nil return on capital employed. It is
unlikely to find the external price basis acceptable since this results in it recording a
negative return on capital employed of 3.6%
The organisation requires the charge basis to provide a stimulus for improvement in
performance at each division.
Division A is likely to seek to reduce its requirement for the stationery and print
service where an ABC cost basis is used for transfers. This will make this approach
appealing to the organisation. Division B, however, records its highest return (20.6%)
where the ABC approach is used and is unlikely to attempt to economise on its use of
the service.
The external supplier price basis provides the organisation with an external
benchmark. This shows that the service division must attempt to reduce its costs
below the current £7m. It also suggests a problem with the structure of the service
division in that its ABC costs to divisions A and B are radically different from the
corresponding external quotes. We have:
Division A Division B
£ £
Internal (ABC) costs 4.16 2.84
External price quotations 2.00 4.50
_____ _____

Net internal (cost)/benefit (2.16) 1.76

_____ _____

This may stimulate action to re-appraise the methods used by the service division.
The organisation is unlikely to find the 50/50 cost based methods acceptable. The
arbitrary nature of the cost apportionment and of the mark-up to the service division
will not provide any stimulus for change at each division.

120 KAPLAN PUBLISHING