CIMA P2: Throughput Accounting

Throughput Accounting is a modern management accounting technique that offers an alternative view to the more traditional cost accounting.

It’s all about identifying the constraint or limiting factor in the production process and exploiting it to maximise profit. It allows management to focus efforts to make the best possible use of the limitation.

Theory of Constraints “TOC”

Goldratt’s Theory of Constrains is a methodology that is covered in the CIMA P2 syllabus and can be applied to systems that are unable to fulfil their goals or targets. Goldratt suggests that any process is only as strong as it’s weakest link and all effort should be focused on removing the constraint by following a five step process.

The constraint in a manufacturing environment is also referred to as a “bottleneck”

  1. Identity Constraint
  2. Decide how to exploit the constraint
  3. Sub ordinate other activities/non-constraints
  4. Elevate the constraint
  5. Repeat the process

These five steps ensure the organisation has an ongoing improvement that is based on the identified constraints or weak links.

And it’s measurements are given via Throughput Accounting – which Goldratt describes as key performance measure.

Throughput Accounting

Is also known as the rate at which the system generates money, it is measured in monetary terms and naturally linked to profitability. Therefore, the objective is achieve the maximum possible throughput profit or “flow”.

Throughput Accounting is based around achieving the maximum possible net profit in a limited time frame with limiting conditions. The formulas used and and a scenario based example is the best way to illustrate how Throughput Accounting can be used and the principles behind it.

Formula and Ratios

Throughput $ = Sales Revenue less Direct Material Costs

Throughput Accounting Ratio (TPAR) = Return per factory hour/Cost per factory hour

Return per factory hour = Throughput $ per unit/Time per unit

Cost per factory hour = Total factory cost/Total time available

The two key formulas here are the Throughput $ and the TPAR – the other formulas are required to understand how to calculate the TPAR.

Below is a scenario of limiting factors and how throughput accounting can be applied as how to maximise profit.

Throughput Accounting

Production Plan to Maximise Profit

The TOC Theory of Constraints in this scenario is the fact the total machine hours is just 32,500 yet to fulfill the demand required we would need 35,000 hours  (15,000*2)+(5000*1).

To calculate the production plan to achieve the maximum profit we need to find the Throughput value per machine hour, which we know is the Selling Price less the Materials/the total machine hours per unit.

Product A $175 (275-90)/2 hours = $92.50

Product B $125 (325-165)/1 hour = $160

With this mind, we need to exploit the constraint by maximising the production of Product B as it gives the highest throughput value and filling the rest of the time with Product A to achieve the maximum profit in these conditions.

Proposed Production Plan

Product B: 5000 units x 1 hours = 5,000 machine hours

Product A: 13,750 units x 2 hours = 27,500 machine hours

Below is a summary of the financials based on this production plan.

CIMA P2 Exam Tips

You can see the total throughput profit (which is considering just the direct materials as a variable cost) gives over 2m profit.

However, the factory (or total fixed costs) need to considered and this is based on the number of units in the original demand and not the proposed production plan as the fixed costs will be incurred regardless of any constraint.

The final result would be a total maximum profit of 421,875.

TPAR – Throughput Accounting Ratio

Finally, let’s look at the TPAR based on the above scenario and see what that tells us.

The TPAR ratio is calculated on each product and is done by dividing the Return Per Factory Hour against the Cost Per Factory.

TPAR - CIMA P2 Exam Tips

You can see that both products have a ratio above 1 which means that the product will be profitable – in simple terms in means that the throughput profit is greater than the fixed costs. In fact you can see that Product B gives a TPAR of a whopping 3.15, so making over three times profit in relation to the fixed costs.

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CIMA P2: Transfer Pricing

Transfer pricing is a subject that crops up on the CIMA P2 paper and here is my take on the subject.

What is Transfer Pricing?

Transfer pricing is common place among multi national corporations where there are high volumes of “inter-company” activity. Companies tend to use transfer pricing to lower their overall tax bill of the group.

Rather than get bogged down with lengthy theory and explainations, I feel the best way to explain is to illustrate with simple examples.

Company NOT using Transfer Pricing

CIMA Transfer Pricing

  • Here you can see a traditional relationship between different departments within a business.
  • Division A makes purchases of raw materials for 80 and after production in A they add labour costs of 20.
  • Division B finalises the product and incurs costs of 40 and sell the product to the end customer for 200.
  • You can see straight away while the Group as a whole has made a profit of 60 from this production, the manager of Division A will be reporting a loss of 100, while his counterpart in Division will be reporting a mega profit of 160.

Company USING Transfer Pricing

CIMA Exam Tips

  • In this instance, the company has an internal agreement to charge a transfer price between divisions.
  • Division A has charged 150 to Division B, while the selling price to the end customer remains the same at 200.
  • You can see the transfer pricing DOES NOT IMPACT the total profit made by the group when consolidated, but it allows each division within the company to be measured efficiently and effectively
  • Therefore, increasing the motivation of the individual division managers to be more cost effective and improve efficiency within the department, which, in turn, improves the profitability of the division and group as a whole.

In the first example, where transfer pricing is not employed the management of division A have no incentive of meaningful performance measurement as they will always considered to be loss making.

Transfer Pricing and Tax Implications

One of the main reasons why large multi national companies use transfer pricing is to accrue profits in countries that have a lower tax rate.

Using the figures from the above example I have illustrated the tax implications if Division A is based in a country with a tax rate of 5% while Division B is based in a country with a tax rate of 20%

CIMA Transfer Pricing and Tax

  • It’s obvious that the company who has implemented transfer pricing will be paying a much lower tax bill due to the fact most of it’s profits are made in Division A where there is a much lower tax rate.
  • However, transfer pricing must be set within the scope of the law and it can become a complex matter. 

The above examples are very simple in terms of the numbers and structure of the business but the underlying principle of transfer pricing remains the same.

Methods of Transfer Pricing

So now we have established what transfer pricing is and the benefits to be made by accruing profits in countries with lower tax rates (within the scope of the law). Let’s take a look at the different methods on how the Transfer Price itself can be calculated.

Cost Plus Price Model

One of the most simplest and common approaches (especially with high volume producing businesses) to be employed is the cost plus price model. This is where the group agrees that the selling business unit will add a fixed percentage to their costs as a base for the transfer price.

Cost Plus Price Model

  • The agreement is for Division A to adopt a fixed cost plus price model of 20% for their transfer price to Division B.
  • Which is fine at the current levels of costs, as both divisions and the group overall are making profits.
  • However, the manager of Division A has realised he can increase the profits of his division by increasing costs – BUT TO THE DETRIMENT OF THE GROUP AS A WHOLE!

CIMA Transfer Pricing

  • Here we can clearly see the dysfunctional behaviour that can be encouraged by using a cost plus price transfer pricing system.
  • Division A manager is happier as he made double the profit by doubling his costs but Division B has made a big loss on this and lead to an overall loss at group level.

In fact, if any divisions are set to lose money on a deal then they will more than likely refuse to do so, even at the expense of the company. Of course, decisions can be made at a group level which enforces the trade between divisions at any cost but it would be demotivating for the buying manager as they lose autonomy.

Minimum Vs Maximum Transfer Price

A more common sense and goal congruent approach is to ensure that firstly the group can make a profit overall, then deciding on the minimum transfer price that can accepted by the selling division and the maximum transfer price that can be accepted by the buying division and them agree on the price somewhere in the middle of the that range.

In the below example I’ve also thrown in the possibility that Division A can also sell the goods directly to an external party.

Determining Transfer Pricing

  • The selling division (A) determines the minimum price of 200 – as they can sell it externally for this price, so the transfer price must at least match this.
  • The buying division (B) has costs of 100 and selling price of 350, so the maximum they could pay would be 250 as a transfer price.
  • This gives the group a transfer price somewhere between 200 and 250 to be goal congruent and suit all divisions involved.

Finally, you can see the transfer price of 200 has been agreed and both divisions make an equal share of the 100 profit made by the group.

CIMA P2: Learning Curves

It’s taken a while for me to get back on track with my CIMA P2 studies but here I am with an article on Learning Curves which is a feature of the CIMA P2 syllabus.

CIMA P2 Exam Tips

The Learning Curve

The learning curve relates to the observed tendency that workers become adept at a task, the more often they perform it. Hence the task will take less and less time the more often it is performed.

This is quite a simplistic way to look at the learning curve but there are many factors to consider when applying the learning curve and ultimately, understanding when and how to use it.

The official CIMA terminology for the learning curve can be found below:
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Learning curve is the mathematical expression of the commonly observed effect that, as complex and labour-intensive procedures are repeated, unit labour times tend to decrease. The equation usually relates the average time taken per unit/batch to the cumulative number of units/batches produced.

– CIMA Terminology

History tells us that the “learning curve” was first observed during the construction of World War 2 aircraft. It was discovered, that, as workers gained more experience building complex aircraft it actually took less time to complete each. And not only that, but the rate at which learning took place was actually predictable.

In reality it was found that the cumulative average time per unit decreased by a fixed percentage each time the cumulative production doubled.

Learning Curve Example

The illustration below is using a learning rate of 80% and gives you a clear overview of the numbers involved.

Cumulative average time learning rate: 80%

Batches Cumulative average time per batch (hours) Cumulative total (hours)
1 100.00 100.00
2 80.00 160.00
4 64.00 256.00
8 51.20 409.60
16 40.96 655.36
32 32.77 1048.58
64 26.21 1677.72
128 20.97 2684.35
256 16.78 4294.97
512 13.42 6871.95

Nevertheless, there is a more scientific way of generating this information above, in the form of an equation, which is expressed as The Learning Curve Formula.

And knowledge of how to use this formula is required for the P2 exam.

The Learning Curve Formula

The learning curve formula is simply expressed as y=ax^b

  • y = cumulative average time taken per unit
  • a = time taken for first unit
  • x = total number of units
  • b = the index of learning
  • where b = the log of learning rate/ the log of 2

It’s a simple equation but perhaps the complex part is using the log tables when calculating the index of learning, as you may not be familiar  with how to apply them on your calculator? I know it was relatively new to me.

While the formula itself gives you the answer for the Cumulative Average Time Taken Per Unit (Y), the CIMA P2 examiner might also ask you to calculate the Index of Learning (b). So it’s important to understand each element of the formula.

P2 Example Question on Learning Curves

CIMA P2 Exam Questions

So to see this formula in action let’s go through it step-by-step.

Q – Company B has a learning rate of 90% and the total time to make the first unit is 8 hours, use the learning curve formula to find out the average time per unit for 16 units

The above question gives us the following information:

a = 8 hours x = 16 units b = ?

  • First of all we need to calculate (b) the index of learning by using log tables.
  • So b = log of 90%/log of 2
  • To calculate this on any scientific calculator you need to press the following:
  • LOG, 0.9/LOG, 2 = -0.152
  • Therefore, the index of learning (b) is -0.152
  • Now we are in a position to complete the question.
  • 8 x 16^-0.152 (8 hours multiply 16 units to the power of -0.152) = 5.25
  • Therefore, the cumulative average time per unit (y) = 5.25 hours
  • Finally, we need to multiply this by 16 units (16 x 5.25) = 84 hours. 

Q – Calculate the index of learning when the learning rate is 80% and it takes 100 hours to produce 1 batch (I’ve used the table in the first illustration as a base for this question).

Here we know the learning curve formula is y=ax^b and b is the index of learning which can be calculated using log tables.

  • b = log of 80%/log of 2
  • Therefore, the index of learning b = -0.32192
  • We can cross check this with the table in my first illustration to prove it’s the correct answer.
  • So let’s use this data to calculate y based on 64 units.
  •  y = 100 (hours taken on first unit) x 64 (number of units) ^-0.321 (the index of learning). Remember the formula y=ax^b.
  • Therefore, based on productions of 64 units, the cumulative time per unit (y) would be = 26.21 hours which is the same figure displayed in my original table.
  • This confirms that the index of learning we calculated is correct.

 

Pass Your CIMA Exams First Time

The Practice Tests Academy founder Justyna Wachulka-Chan explains, using her own experience on passing CIMA exams, how students can also pass their exams first time. 

pass your CIMA exam first time

I bet you have often wondered what does it take to pass a CIMA exam on your first attempt?  The bad news is that there is no one-fits-all solution, BUT there are some tips you can take in, incorporate in your studying routine in order to increase your chances of passing.

Sometimes we need a little help or guidance from others. I know that perfectly as I have failed and then passed CIMA exams last year.

That inspired me to create a guide for CIMA students explaining my point of view and what does it take to pass an exam. Hopefully you will find it beneficial. This guide can be downloaded for free from here.

The CIMA 2015 Syllabus

I always say that passing an exam, especially according to the 2015 syllabus, is not only about the knowledge, but also about the exam technique you have – I need to stress that here! Of course, your knowledge has to be impeccable, but you also have to train how to answer the questions under exam conditions.

In this way you learn how to quickly assess if actually you are able to answer that particular question and how long that is going to take you.

When you approach a question, you need to very quickly realize what is the topic that it covers and you HAVE TO be honest with yourself. If it’s something that you don’t know or you always had issues with, don’t spend a lot of time on this question. Just cross out the obvious wrong answers. If you are then left with two options, just go with your guts.

Pick an answer and flag this question for later review, so in case you have extra time at the end of the exam, you can always come back to it. But decide something quickly. Don’t spend more than half a minute on this question if you know that you are not really familiar with the topic.

Exam Practice is Key for CIMA exams

CIMA Mock Exams

What I’m trying to say here is that unless you practice enough before the final exam, you may waste your precious answering time on trying to depict how everything works.

Sometimes that extra 2-3 minutes is what you need in order to PASS.

I hear quite often that some students reached 97 points… That means that if only they managed to answer 1 more question, they would have passed. Maybe they didn’t have enough time (wrong time management) or simply they were too stressed after throughout the exam and especially after seeing that “5 minutes to the end” reminder. Do you see where I’m getting at? Why to create that situation if you can avoid it just by practicing some online questions beforehand.

Practicing is a key to your CIMA success.

Practicing will accelerate your learning and should help you cement your knowledge in preparation for your exam. So if you have a possibility to practice more and more questions that you have not done before, take this chance and do it. It will only help you. If you don’t know where you can find plenty of questions to try, Practice Tests Academy site offers 500 interactive questions per each CIMA paper.  These questions have been designed to copy the style and format of questions found in the real CIMA Objective Test exams.

The Real World and CIMA Objective Tests

CIMA is constantly claiming that their examination style is adjusted to the needs of the employers. And I really believe so. Just think about it….

In a corporate world you are overloaded with information, with data. But you need to act fast when your boss comes and ask you a question.

You need to know where to quickly check and give the answer. The times of providing an answer a day later by giving a lengthy report are gone. In most cases, you have a dashboard and you need to understand what those numbers mean. In the current format of CIMA exams you can see exactly that.  They check if you understand the concept, not how much you know about it (like it was before). And that is what employers are looking for.

So personally I think those tests are more adjusted to the fast-paced work environment and therefore better for you as they teach you to become more agile in your daily work.

A Rational Approach to CIMA Exams

My recommended approach, based on my own and other students’ experience, focuses on:

  • Setting practical exam deadlines. You need to set an upper-limit to your study-endeavor, which then introduces an element of direction and inspires achievement. Despite being on-demand, you need to be swift in your approach to your CIMA education. Taking too much time may result in a higher opportunity cost in the job market whilst taking too little will backfire.

 

  • Covering all aspects of the syllabus. You need to study the textbook, almost to the point of memorizing it. OTQs will test your knowledge across most (if not all) areas of the syllabus, your understanding of concepts, and your ability to apply to simple contexts.

 

  • Practicing plenty of mock exams. Plenty of it. Practice exams fine-tune your approach, including essential time-management skills. It also develops a sense of confidence which will at best inspire a lasting habit of preparing whilst at least provide you an edge over the nerves usually implied while taking an exam.

There is no room for complacency and you will need to work hard to be successful!

If you’d like to read more on this you can find the free ebook on how to pass CIMA exams from the Practice Tests Academy here. Meanwhile, their extensive set of mock exam style questions can be found on their website here.

CIMA OCS February 2017: Mavis Venderby

CIMA Feb 2017 OCS Exam Tips

CIMA released the pre-seen materials for the OCS February exam last Friday 9th December and the case study in question is called “Mavis Venderby”.

You can find the official OCS pre-seen materials from CIMA here.

I posted an article earlier this month on CIMA Case Study Advice: February 2017 that will give you some more pointers and advice on how to approach the case study and the different resources available to you – ranging from post exam kits to study advice.

For those interested in the complete Astranti OCS course for Mavis Venderby you can find it here.

Mavis Venderby: Who are they?

The company in the OCS exam, Mavis Venderby, produces (manufactures and retails) wooden beehives. Here are a few key pointers and background information taken from the pre-seen materials.

  • Family run business that’s been in operation for 70 years.
  • Mavis Vendery sells all products direct to customers.
  • There is a shop on site in the factory but the bulk of sales are made online or via telephone.
  • The company recently moved premises with plenty of scope for expansion.
  • The company is equally owned by the managing direction Thomas Venderby (Mavis’ son) and Jacinta Cory (Mavis’ great grandchild).

Mavis Venderby: Pre-Seen Video Analysis

The below video is a preview of the Astranti pre-seen analysis on Mavis Venderby, I would suggest to go through the pre-seen materials once by your self and make notes then watch the full video from Astanti and line up your comments against the tutors.

It’s a crucial part of understanding the pre-seen as it lays down the foundation you need to pass the OCS first time.

You can find the full set of videos on the February OCS here.

Mavis Venderby: Strategic Video Analysis

The strategic analysis of the company should be done next. Again, I would suggest drawing up a list of Mavis Venderbys strengths and weaknesses with a SWOT analysis. Then watch the Astranti video to see if you’re on the right track, it will also give you a fuller picture of the company.

But you can still find the full set of videos on the February OCS here.

Mavis Venderby: Top 10 Issues

The top 10 issues is a great way to give you some focus for your studies. The tutor identifies, in their opinion, what the most likely topics and questions will crop up on exam day based on what’s available in the pre-seen materials.

But you can still find the full set of videos on the February OCS here.

CIMA E2: Company Culture

CIMA E2 Culture Exam Tips

Understanding company culture is part of the CIMA E2 syllabus and is an easy one for most people to relate (assuming you have some experience in the workplace).

Culture is described as a combination of beliefs, values and standards of behaviour that are inherent in an organisation.

Company Culture

For example, you might work in an office where, despite the normal working hours being 9am to 5pm, your colleagues all arrive early at 8am. This pattern of behaviour tends to influence others to arrive at the same time, likewise if no one is in the office until 9pm but stays late then this company culture would also influence others in the work place.

Charles Handy describes culture as “The way we do things around here”.

You may believe that management looks at company culture as a topic with low priority in the organisation but in reality it couldn’t be further from the truth.

Ensuring a companies culture is consistent with the organisations future direction and strategy is critical to strategical success!

Having a positive company culture such as being a Corporate Social Responsible employer will help attract and retain top performing staff.

Also when there are so many companies out there competing for the top talent, they need to stand out and offer more than just an attractive salary, so being renowned for having an excellent company culture that keeps employees happy and engaged will be key to the company achieving long term and sustainable success.

Charles Handys Cultural Model

Charles Handy suggests there are four over-riding types of culture inherent in an organisation. Let’s take a look at them.

POWER CULTURE

First up is what is known as the “power” culture where is typically one central source of power who makes all of the decisions and the employees have to follow. It’s commonly seen in smaller companies where the owner is the manager/director.

There are few procedures and rules as there are no need for them. The owner makes the decisions and that’s that!

The Power Culture can also be described as the web culture. For instance, the spider that made the web controls and dictates what happens – it’s one central source of power.

TASK CULTURE

The “task” culture focuses on getting the job done and can be associated with project management or complex matrix organisations. The employees are focused on getting their job done and not so concerned with their place within the company.

It requires good communication with a clear emphasis on getting the job done and going home for the day – as opposed to concentrating on the team spirit or relationships within the company.

ROLE CULTURE

Is found in workplaces like the government offices or large bureaucratic companies. Unlike the power culture, the role culture has lots of formal rules and procedures that must be followed by all employees.

There is a formal structure in place with every employee having a clear set of roles and responsibilities that must be followed. It’s clear that each role and position in the company has it’s part to play but employees must not cross the boundaries of their roles and responsibilities.

PERSON CULTURE

Finally the person culture exists to satisfy the individual rather than the team or the collective. It’s commonly found in sales organisations where the salesmen work independently and for their own benefits (commission on sales).

It can also be linked to legal work such as barristers and legal representatives who work for themselves.

In the person culture, each individual operates independently.

CIMA E2: Managing Change

Syllabus area D of the CIMA E2 paper revolves around managing change through projects. It’s covers 30% of the paper so you need to know enough detail to be able pass the E2 objective test.

CIMA E2 Resources

Lewins 3 step model of change

Our good friend Lewin is back with another model, this time it’s his theory on the 3 step approach to successful change management.

UNFREEZE

The first is based around unfreezing the current behaviour in the work place so when the change happens, it will be a smooth transition and successful project.

It also gets staff ready and motivated for the change, thus is crucial as if the staff do not buy in to the proposed changes, then chances are it will fail.

You need to remember the 3 C’s here.

Consultation: here management would actively involve their staff and get ideas from them on how to implement the change. Therefore, effectively getting everyone on board for the change.

Communication: the reasons why the change is happening needs to be communicated properly to all staff. Otherwise, morale will suffer and the execution of the change will not happen smoothly if no one understands why this is happening?

Counseling: finally, in the unfreeze stage, management need to deal with the issues raised from the staff about the proposed changes. Making sure people’s grievances are dealt with. The benefits of the change may need to be communicated again so everyone is happy with the direction that will be taken.

MOVE

This is when the change is actually happening and can be done in various forms – Lewin suggests change should be facilitated through;

Project Management: this will ensure the whole change process is managed effectively and the end targets are met.

Change Agents: these are specific people who are brought into the process to gain peoples buy in and they are responsible for the making the change successful.

New Procedures and Rules: once the change has taken place, the new procedures are rules will need to established and effectively communicated to the rest of the staff to ensure the change implemented will work long-term and staff are comfortable with the new rules.

REFREEZE

Once the new behaviours and approaches have been implemented, we then enter the RE-FREEZE stage. It’s key that staff and management do not fall back into the old ways, so the new approach must be “re-frozen” into the company culture and way of doing things.

This is usually done by:

Individual Rewards: by rewarding employees who are following the new changes, this will encourage others to follow suit and ensure the change implemented is successful.

Disciplinary: likewise, for those members of staff who are not following the way of working, they should be disciplined for failure of adopting the change.

Communication: this is key in all areas of the change management process and it also shouldn’t be forgotten in the final stage. By communicating the benefits of the change again, this will re-inforce the idea the change will benefit all involved.

Kotter’s 8 Step Change Process

Another model that could be tested in the CIMA E2 exam is Kotter’s 8 Steps in the Change Process. It maybe a challenge to memorise all of the models and theories that are in the E2 syllabus but you should approach them in a pragmatic.

For example: Kotters 8 Step Change Process and Lewin’s 3 Step Model of Change are on the same topic so you can relate them both together to get a better understanding.

This of Lewin’s 3 steps as a high level view of what Kotter is saying with his 8 step change process. The diagram at the bottom of the article illustrates the point I am trying to make. But first, let’s look at the 8 steps that Kotter is talking about.

  • Establish a sense of urgency.
  • Create a guiding coalition.
  • Develop a change vision and strategy.
  • Communicate the vision and strategy.
  • Empower staff and remove any barriers.
  • Short-term wins.
  • Consolidate the gains.
  • Anchor in the culture.

By understanding the 8 steps in the order Kotter has mentioned above you can see they all fall into the same three categories Lewis mentioned: Un-Freeze, Move and Re-Freeze.

CIMA E2 Exam Tips

Lewin’s theory is illustrated with the 3 arrows on the left hand side of the above image, while Kotter’s 8 steps in the change process are illustrated by the text next to each arrow.

I got this idea to combine the two theories when watching the CIMA E2 astranti master class – having this additional resource works well for me as I am self studying the whole syllabus – so tutor advice is always welcome! So these masterclasses have been invaluable to me.