Performance Management: In the First of Two Articles, Ian Janes Analyses the Principles Underpinning the Types of Decision-Making Scenarios to Be Found in the New P2 Paper

By Janes, Ian | Financial Management (UK), November-December 2009 | Go to article overview

Performance Management: In the First of Two Articles, Ian Janes Analyses the Principles Underpinning the Types of Decision-Making Scenarios to Be Found in the New P2 Paper


Janes, Ian, Financial Management (UK)


Decision-making is a big part of most accountants' jobs. They regularly have to take, or provide the information for, key business decisions, both on a day-to-day basis and for the longer term. This is also true of candidates studying paper P2, which requires many fundamental choices to be made.

[ILLUSTRATION OMITTED]

Probably the most crucial element in decision-making is the cost-benefit analysis, where we take into account the cost and revenue implications of the options open to us. It's important to recognise that making decisions on a financial accounting (absorption) costing basis is likely to be inappropriate, because the fixed cost element may not be affected by a particular course of action. Instead, many decisions are based on contribution. The measurement of this (contribution per unit equals the selling price per unit minus the variable cost per unit) is really a form of marginal or cost-benefit analysis that's used when you're faced with choices such as selecting which products to make if there's a shortage of resources, or deciding whether to accept or reject a sales order.

More generally, if the benefits of doing something will exceed the costs, the decision should be to go ahead and do it, but many benefits and costs are difficult to quantify. For example, we can all appreciate that working a few hours' overtime costs us some leisure time in order to earn some extra money. Harder to measure is the less tangible benefit of getting the job done balanced against the cost of, say, feeling more tired. Fortunately, the decision-making problems you will encounter in the P2 exam will focus on the variables that we can measure and analyse more easily.

Let's consider how we can use contribution analysis to solve a problem concerning scarce resources, which is a scenario that's regularly examined. Obviously, for most companies in most situations, market demand will be the limiting factor on operations--businesses will do their utmost to ensure that they have the resources to make a sale. But what if there's an unavoidable short-term lack of, say, skilled labour or a particular component? The key concept here is that the most beneficial production plan will be made when we prioritise production in such a way that the contribution per unit of the scarce resource is maximised.

Consider company X, which provides three different services, denominated as units of service for ease of analysis (see table 1, previous page). If labour hours are a limiting factor, then the provision of services needs to be prioritised. Note that any fixed costs are not relevant to the decision, providing that all three services use the same central facilities.

The incorrect response would be to state that BL501 is the best service to provide at 60 [pounds sterling] contribution per unit; then SJ301 at 48 [pounds sterling] per unit if resources allow; and, lastly, GS365 at 40 [pounds sterling] per unit if there are any hours left. This is the answer of a weak candidate. In a multiple-choice objective test question it would undoubtedly be included as one of the incorrect options.

The correct response is to consider the contribution per labour hour. That makes GS365 the service to prioritise, because it gives the best return (cost-benefit trade-off) of 33.33 [pounds sterling] per unit per labour hour. Next in line is S J301 (12 [pounds sterling]) and only then, if resources allow, BL501 (10 [pounds sterling]).

If you're still unconvinced that GS365 is the top-priority service, suppose that there are only 60 labour hours available. In this time company X could provide: 20 units of GS365, giving a contribution of 20 x 40 [pounds sterling] = 800 [pounds sterling]; or 15 units of SJ301, giving a smaller contribution of 720 [pounds sterling]; or only ten units of BL501, giving a contribution of a mere 600 [pounds sterling].

Of course, there may not be demand for 20 units of GS365. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Performance Management: In the First of Two Articles, Ian Janes Analyses the Principles Underpinning the Types of Decision-Making Scenarios to Be Found in the New P2 Paper
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.