F5 Performance Management

AMTRAS
Institute of Professional Studies Quantitative Analysis In Budgeting

Monitored By : Faridul Date

Abedin RAFI

:__________________

1. High/low analysis
High/low analysis can be used to analyse Semi-Variable into fixed costs and variable costs per unit whenever: there are figures available for total costs at two different levels of output or activity it can be assumed that fixed costs are the same in total at each level of activity, and the variable cost per unit is constant at both levels of activity. Step 1: Variable Cost/Unit = Cost @ High Activity level Cost @ Low Activity Level / High Activity Low Activity Step 2: Fixed Cost = Total Cost (@ High Activity Level) Variable cost/unit * Activity Level ( High Activity) Example : Output ( Units) Total Cost $ 200 7000 300 8000 400 9000 Required : 1.Calculate Variable cost /unit and Fixed Cost. 2.Estimate Total cost if output level is 350 units and 600 units Example A company has recorded the following costs in the past six months: Month January February March Activity Direct labour hours 5,800 7,700 8,200
2

Total cost $ 40,300 47,100 48,700

April May June

6,100 6,500 7,500

40,600 44,500 47,100

Required Using high/low analysis, prepare an estimate of total costs in July if output is expected to be 7,000 direct labour hours.

1.1.High Low Method with Stepped Fixed Cost:

Activity
4000

6000 7500

Total Cost $ 40800 50000 54800

Variable cost unit is constant within this activity level and there is step up of 10% in fixed cost when the activity level exceed 5500 units. Calculate the Total cost at 5000 units?

1.2 High Low Method with change in Variable cost / unit

Example : Output ( Units) 200 300 400 Total Cost $ 7000 8000 8600

For Output volume above 350 units the variable cost per unit falls by 10% (this falls applies to all units not just excess above 350 units) Calculate the cost for 450 units?

Example: The total cost incurred in 2003 at various output

levels in a factory have been measured as follows: Output (units) 26 30 33 44 48 50 Total cost $ 6566 6510 6800 6985 7380 7310

When output is 80 units or more , another factory unit must be rented and fixed cost therefore increase by 100%. Variable cost per unit is forecast to rise 10% in 2004 Required: Calculate the Total cost for output level of 100 units in 2004(14930)

2. Simple average growth models

A growth rate can be estimated from an analysis of the growth in, for example sales, over the past few years. Year 20X1 20X2 Sales revenue ($) 150,000 192,000
4

20X3 20X4 20X5

206,000 245,000 262,350

Required : Calculate the average growth rate?

3. Forecasting techniques
As we have seen linear regression can be used as a forecasting tool, other methods include time series analysis, average growth models and estimations using judgement and experience

Time series analysis

An analysis of past patterns of demand or sales which will be used to construct expected patterns in the future. Components of a time series (a) Trend (T): the underlying increase or decrease in demand. For example, a steady decline in the average sales of a national daily newspaper or a steady increase in sales of Sony PlayStations. (b) Seasonal variations (SV): short-term repeated fluctuations from the trend. For example, sales of tabloid newspapers being higher on Mondays and Saturdays than other days due to the extra sports coverage, or sales of ice cream being higher in summer than in winter. (c) Cyclical variations: recurring patterns over a longer period of time, not generally of a fixed nature.

For example, changes in unemployment, movement from recession to economic growth. (d) Random variations: these will be included in past data but could not be included in future estimates. For example, high sales of a tabloid newspaper due to exclusive photographs of a member of the royals in a compromising position. The additive model and the multiplicative (proportional)model In the additive model the components are assumed to add together to give the time series (TS). TS = T + SV The multiplicative model multiplies the components together. TS = T x SV Trend and seasonal variation The trend can be found using moving averages. If seasonal variations repeat after four periods, say, we can smooth out these variations, and calculate the underlying trend, by looking at averages for each quarters figures. Then each average can be compared to an actual value and the seasonal variation found: Additive model: SV = TS T Multiplicative model: SV = T / TS

4. Learning curves
Learning curve theory may be useful for forecasting production time and labour costs in certain circumstances, although the method has many limitations. Whenever an individual starts a job which is fairly repetitive in nature, and provided that his speed of working is not dictated to him by the speed of machinery (as it would be on a production line), he is likely to become more confident and knowledgeable about the work as he gains experience, to become more efficient, and to do the work more quickly. Eventually, however, when he has acquired enough experience, there will be nothing more for him to learn, and so the learning process will stop.

Learning curve theory applies to situations where the work force as a whole improves in efficiency with experience. The learning effect or learning curve effect describes the speeding up of a job with repeated performance.

4.1 The tabular approach: cumulative average time and the learning rate
The tabular approach is only effective in scenarios where output is doubling. Under this approach, a table is set up to show levels of output, cumulative average time required per unit and incremental time for additional units. The cumulative average time per unit produced is assumed to decrease by a constant percentage every time total output of the product doubles. For instance, where an 80% learning effect occurs, the cumulative average time required per unit of output is reduced to 80% of the previous cumulative average time when output is doubled. (a) By cumulative average time, we mean the average time per unit for all units produced so far, back to and including the first unit made. (b) The doubling of output is an important feature of the learning curve measurement.

Example: the learning curve

Captain Kitts has designed a new type of sailing boat, for which the cost of the first boat to be produced has been estimated as follows:
8

Materials Labour (800 hrs $5 per hr) Overhead (150% of labour cost) Total Profit mark-up (20%) Sales price

$ 5,000 4,000 6,000 15,000 3,000 18,000

It is planned to sell all the yachts at full cost plus 20%. An 80% learning curve is expected to apply to the production work. The management accountant has been asked to provide cost information so that decisions can be made on what price to charge. (a) What is the separate cost of a second yacht? (b) What would be the cost per unit for a third and a fourth yacht, if they are ordered separately later on? (c) If they were all ordered now, could Captain Kitts quote a single unit price for four yachts and eight yachts?

Example:

Bortamord anticipates that a 90% learning curve will apply to the production of a new item. The first item will cost $2,000 in materials, and will take 500 labour hours. The cost per hour for labour and variable overhead is $5. You are required to calculate the total cost for the first unit and for the first 8 units.

4.2.The algebraic approach

The formula for the learning curve is Y = axb, where b, the learning coefficient or learning index, is defined as (log of the learning rate/log of 2). The learning curve formula can be used to solve all learning curve scenarios. The formula for the learning curve is Y = axb where Y is the cumulative average time per unit to produce x units x is the cumulative number of units a is the time taken for the first unit of output b is the index of learning (logLR/log2) LR is the learning rate as a decimal Limitations of learning curve theory (a) The learning curve phenomenon is not always present. (b) It assumes stable conditions at work which will enable learning to take place. This is not always practicable, for example because of labour turnover. (c) It must also assume a certain degree of motivation amongst employees. (d) Breaks between repeating production of an item must not be too long, or workers will 'forget' and the learning process will have to begin all over again. (e) It might be difficult to obtain accurate data to decide what the learning curve is.
10

(f) Workers might not agree to a gradual reduction in production times per unit. g) Production techniques might change, or product design alterations might be made, so that it takes a long time for a 'standard' production method to emerge, to which a learning effect will apply

Example:
A company needs to calculate a new standard cost for one of its products. When the product was introduced, the standard variable cost of the first unit was as follows. Cost per unit $ Direct material 10 kg @ $3 per kg Direct labour 10 hours @ $9 per hour Variable overhead 10 hours @ $5 per hour Total 30 90 50

170

During the following year, a 90% learning curve was observed. The cumulative production at the end of the third quarter was 50 units and the budgeted production for the fourth quarter is 10 units. Required (a) What is the standard cost per unit for the fourth quarter assuming that the 90% learning curve still applies? (b) What is the standard cost per unit for the fourth quarter assuming the learning curve had reached a steady state ie peak efficiency was reached after the 50th unit was produced?

11

12