Alean information system should provide value to the users of the system. Key principles are the elimination of waste, speed of information flow, and clarity.

Elimination of waste – A lean system seeks to eliminate all waste. In an information system, waste is created by errors in the information, which means that incorrect information is used and wrong decisions may be taken. Alternatively, the information has to be corrected when the error is identified, and this results in a cost of correction. Correcting errors does not add value, because the error should not have occurred, and correcting errors is wasted effort.

Efficiency in the flow of information – A lean manufacturing system is one in which there is an efficient flow of items through the manufacturing process. In a lean information system, there should be an efficient flow of information. Information should be available to individuals when they need it, and there should not be unnecessary delays in providing it or making it available.

While efficiency in the flow of information means that information should be available when it is needed, it should not be provided before it is needed. Information should be available ‘just in time’ (JIT). This is the concept of pulling items through the system rather than pushing them through. If information is provided before individuals are ready to use it, it does not have value.

Clarity is also an element of lean information. Information must be clear to the people who use it and should therefore be presented in a form that they can understand and use. If information is presented in a form that is difficult to understand, it will be difficult to use. Unless it is used for its intended purposes, information has no value.

Together, the elimination of waste, efficiency of information flow, and clarity of information are qualities of an information system that give value to the information that the system produces.

Reasons why lean principles may not lead to improvements in productivity and profitability

In many situations, an organisation supposedly using lean principles has not experienced the improvements in productivity and profitability expected. It is difficult to know whether this is due to shortcomings in the lean philosophy or whether the techniques involved are being interpreted and applied correctly.

Change in approach – To be successful, lean techniques should be seen and treated as outward signs of a more fundamental approach to operations and quality. However, many organisations seem to treat the techniques as the end itself – they have a mistaken belief that simply putting structures and mechanisms (e.g. quality circles) in place will improve efficiency and quality. Sustainable differences require a change in thinking and in culture – which are difficult to achieve.

Cost-cutting exercise – Lean production is often viewed as a simple cost-cutting exercise rather than a fundamental commitment to eliminating waste and adding value. Many companies use lean manufacturing to improve quality and reduce costs. But the benefits most businesses realise are only a fraction of what could be achieved if these strategies were applied in conjunction with the aim of creating a workplace with real organisation and order, and with an engaged workforce who take pride in their work.

There are several reasons why BEN’s current management accounting system does not fulfil the requirements of a lean information system.

Errors – There are many errors in data capture for the cost accounting system. Errors represent waste in the system, by providing incorrect information about costs, or requiring correction when the errors are found. Errors also reduce the confidence of users in the information that the system provides.

 ‘Push’ system – Monthly variance reports are provided but not until two months after the end of the month. There are two weaknesses in this reporting system. The first is the delay in making information available if required. The information about performance is being held by accountants and is not made available to the managers who can use it.

The second problem is that the information is pushed out to management in the form of monthly variance reports, when it would be more appropriate to make the information available when management want to use it for monitoring and control purposes. The information system is dictating how and when the information should be used, whereas management should be doing this.

Not encouraging lean manufacturing – More fundamentally, it can be argued that traditional cost and management accounting methods provide managers with inappropriate information that encourages the wrong sorts of management for an organisation that uses lean manufacturing methods. A key feature of lean manufacturing is the elimination of inventory, because holding inventory is wasteful. Absorption costing, however, encourages manufacturing at full capacity, even if this means manufacturing items that are not yet needed by customers, so that inventory will build up. This is because high volumes of production reduce the unit costs of manufacture by spreading overhead costs over a larger volume of output.

Variance reporting of efficiency also encourages greater volumes of output, because greater efficiency means faster production. When the workforce is paid a fixed wage or salary, attempts to improve efficiency will result in greater production quantities and a build-up of inventory.

The current reporting systems therefore encourage managers to control operations in a way that is inconsistent with lean manufacturing.

Error reduction – To create a lean management accounting system, waste must be eliminated and information flow improved. The causes of the data errors in data capture are not known. The problem may be the use of manual documentation for recording costs, or errors in input by inadequately trained staff. Methods of recording costs should be investigated, and the target should be to eliminate input errors entirely.

Flows of information – The flow of information must be improved, so that up-to-date information is available to management when they want it. The speed of entering data into the accounting system should be reviewed, and the aim should be to minimise the delay between recording data and inputting it into the accounting system. Automated methods of monitoring inventory movement or recording labour times may be considered.

User access to information – The accounting system should also allow managers online access to information about costs, so that they can obtain and use the information they need at a time that they need it. This should apply to senior management as well as to management at the operational level.

Cost allocation – The information provided by the accounting system should be reviewed, and absorption costing should be abandoned. There may be some value in using activity-based management to monitor and control overhead costs, but the most important requirement should be to value inventory at direct materials’ cost. This means that there will be no incentive to produce at high capacity volumes or operate at unnecessary levels of efficiency. Favourable capacity and efficiency variances will not affect inventory costs and so will not improve management performance.

Performance measures – Different items of information should be provided for performance measurement purposes. Traditional performance measurement methods for materials – price and usage variances – should be used to control materials costs. For labour, however, non-financial measures of performance may be appropriate, such as production cycle times of throughput times and the ratio of idle time to active time for the workforce. The company is considering JIT purchasing for its main suppliers: if so, a suitable measure of performance may be the order to delivery cycle time for purchase orders.

In a lean information system, information should have a practical use and support the aims of management. The management accounting system should be changed so that it provides value – a practical purpose, with no waste, rapid information flow and clarity of meaning.

Costs and benefits of the system

Cost – There is likely to be considerable cost associated with the hardware and software needed to establish the RFID system. A significant amount of time may also be required to tag the equipment and drugs which are to be included in the system. However, the costs should be compared to the benefits which will accrue from the system:

Efficiency savings – Hospital staff will save time because they will no longer have to search for items once those items have been tagged.

Patient care – Improvements in patient care as a result of hospital staff being able to find equipment or drugs immediately rather than having to search for them.

Impact of the nature of the information supplied

Non-financial information – Although the information being supplied about Quark’s equipment and inventory is non-financial (relating to the location and quantity of equipment and drugs in Quark’s hospitals), it should already be included in the hospital’s information systems. Timeliness and accuracy – However, the major impact of the new system should come from the improvements it can provide to the timeliness and accuracy of the information being recorded. The RFID tags will update information on a real-time basis. Moreover, because movements are recorded automatically the problem of the register not correctly reflecting the physical location of an asset will be overcome.

Batches of drugs – However, the quality of the information provided by the RFID tags may be less reliable for the drugs which are delivered in a single packaged batch. If a tag is applied to a batch as a whole when it is delivered to the hospital, then the information provided by the tag will no longer be reliable once the batch is opened and drugs are used from it. Instead, there will still be a need for the hospital to physically count the quantities of these drugs actually held in inventory, rather than relying on the RFID information alone.

Performance management reporting

Weekly physical checks – Under its existing systems, Quark has to make weekly physical checks of the drugs held in inventory in order to update its records on the basis of those checks. However, the information provided by the RFID tags should mean that inventory records can be updated on a real-time basis, rather than being dependent on these weekly checks.

Access to information – The fact that the RFID information will be available on terminals throughout the hospitals should also help the speed with which staff can locate items of inventory or equipment. The ease and speed with which staff can search the information will depend on the number of terminals which are installed. It would also be useful for relevant staff to receive training on how to search for information on the terminals.

Improved control

Control over drugs – Quark’s existing accounting systems aim to avoid theft and obsolescence of equipment and drugs. RFID tags should improve controls over security by providing greater transparency about the location of assets. For example, the tags will make it easy for staff to check that all the high-value drugs are stored in secure locations, thereby reducing the risk of them being stolen.

Reduced obsolescence – Additionally, the information available about the date drugs were delivered should help staff identify the order in which different batches of a drug should be used to prevent obsolescence and wastage.

Tagging equipment – We have already noted that tagging items of equipment will allow staff to find them more quickly and thereby provide faster service to patients. However, the RFID tags will also enable the hospitals’ management teams to ensure that pieces of equipment are replaced and locked away in secure areas once they have been used. This again should help reduce the risk of theft, but perhaps equally importantly staff should be reminded of the importance of replacing items after they have been used, and of storing them in useful locations. This also links to the ideas of ‘lean’ systems which the CFO is interested in.

Lean systems

Removal of waste – The aim of ‘lean’ systems is to minimise the amount of resources (including time) which are consumed by the activities of an organisation. A key element of this comes from identifying and eliminating all non-value adding activities. In this context, ‘lean’ also involves the systematic elimination of waste.

In relation to information systems, waste arises from difficulties in accessing and retrieving information, or from having to correct inaccurate information. This kind of ‘waste’ has clearly been an issue for Quark – for example, where staff have had to waste time looking for equipment or drugs which have not been not stored in the correct place. Such activity is clearly not value adding; rather it detracts from the value (care) which Quark can offer to its patients.

Improved efficiency – In contrast to this, the goal of a ‘lean’ operating system is to get the right things to the right place at the right time. In the context of Quark, this could mean enabling staff to know where equipment is so that it can be made available in the right place when it is needed by patients. Consequently, introducing the RFID system should help the operations management at the hospitals become leaner.

‘Lean’ systems can also have wider cultural implications which could be beneficial at the hospitals, in particular in relation to changing attitudes towards ‘waste’ and ‘inefficiency’. The instances of equipment lying unused in one area of the hospital while being searched for in another area (to the detriment of patient care) would seem to be symptomatic of waste and inefficiency in the hospitals.

5 Ss – Lean principles are often characterised through 5 Ss, which could usefully be introduced at Quark:

Structurise – Identify the things which are most important and introduce order where possible. At Quark this could mean identifying the optimal locations for storing equipment, on the basis of where it is used most frequently.

Systemise – Arrange essential items in order so that they can be quickly and easily accessed. The RFID system will make it easier for staff to locate the equipment and drugs they need.

Sanitise – Keep the working environment clean. Be tidy, and avoid clutter. Although the RFID system should help staff to find drugs and equipment more easily, there is a danger that staff may think that this reduces the need for them to replace them after use, or to keep stocks of drugs tidy and in order.

Standardise – Make cleaning and checking a routine. For example, the RFID information could be used by management to check that equipment is replaced after use; and staff could even be monitored on the extent to which they keep their sections of the hospitals tidy.

Self-discipline – Sustain via motivation; for example, by reporting on performance. The system could produce exception reports highlighting pieces of equipment which had not been returned to a secure store once they were no longer being used. Corrective action can then be taken to return the equipment to an appropriate store area.

Impact of the RFID system

In some organisations, 5Ss has become a cleaning and housekeeping exercise only, and the underlying philosophy behind the concept has been lost. If this happens, then RFID’s ability to make the management system leaner will be reduced. However, if the RFID information system is seen as an important part of quality management at the hospitals, then its impact should be more beneficial.

Key stakeholders – The medical staff are likely to be key stakeholders in the hospitals, so their attitude to the new system is likely to be very important. If they resist the system, then its implementation is unlikely to be successful, as appears to have been the case with the new method for recording drugs administered to patients. In this respect, it will be important to consult the medical staff over the design and implementation of the RFID system. Not only does consulting them recognise their position as key stakeholders, but also it gives them the opportunity to ensure the system is designed in a way which provides them with the information they need.

Improvements to patient care – Crucially, consulting the medical staff about the design of the system should help encourage them to accept it rather than resist it. Equally, it will be important that medical staff realise that the primary purpose of the system is to enable equipment and drugs to be found more easily – thereby improving patient care – rather than as a piece of bureaucracy. If the medical staff realise the benefits of the system, they should be more willing to accept it.

Usability – The user-friendliness and ease of use of the new system will also influence how successfully it will be implemented.

Again, this highlights the importance of consulting the medical staff, to ensure that the system is designed in a way which makes it easy for them to use. Some of the complaints from the nurses and specialist doctors about the new method of drug administration may have been caused by the system proving difficult or time consuming to use.

Responsibility and accountability

The RFID system will provide much greater transparency as to where equipment or drugs are actually being stored, and can provide management with the information to control how well staff are looking after the hospitals’ assets. However, in itself, the system cannot promote responsibility or accountability.

Quark will also need to identify who is responsible for ensuring assets are held in the right place at the right time. For example, responsibility schedules could be introduced for each department or ward identifying which assets the nurses are responsible for and which the doctors are responsible for.

Quark’s management should only hold people accountable for assets being in the right place if those people have control over how and where those assets are used. For example, can a nurse be held accountable for equipment being in the wrong place if a doctor has moved it? Crucially, if nurses start being criticised for items not being stored in the correct place when those items have been moved by a specialist doctor, this is likely to demotivate the nurses, and could also create resentment between the nurses and the doctors.

Setting objectives

Range of stakeholders – As a public sector organisation, GNT has a wide range of stakeholders, including: government, Oxfords, Arena companies, the rail regulator, and society as a whole (for example in relation to carbon emissions). The three subsidiary companies (Oxford, Arena, Steven) could also be viewed as stakeholders of GNT.

However, the different stakeholder groups have different expectations of GNT, which in turn means that GNT has multiple objectives to achieve.

Prioritising objectives – Unlike commercial organisations, which have an underlying objective to be profitable and to deliver value for their shareholders, as a public sector organisation, GNT does not have a single defining objective of this kind.

The number of elements in GNT’s current strategic objectives highlights the potential difficulties of identifying which elements of performance are most important: reliability, punctuality, safety, cost effectiveness, or environmental impact.

Conflicting interests – Moreover, the nature of these objectives means that GNT may inevitably not be able to achieve all of them, because some of them could be mutually exclusive. For example, GNT might be able to improve reliability and safety, and possibly also to reduce its environmental impact, by investing in new trains, but such a major investment would have significant cost implications, and therefore may not be viewed as being cost effective.

This again highlights the difficulty GNT faces in trying to satisfy the needs of different stakeholder groups. For example, the decision to reduce the number of Oxford services on (less profitable) rural routes appears to be driven by a need for cost effectiveness, but reducing the level of services has a detrimental impact on local residents for whom the rail service provided a vital means of transport.

To complicate matters further for GNT, in some cases single stakeholder groups may have multiple interests in the railway. This increases the difficulty GNT has in prioritising its objectives. For example, while supermarkets are clearly concerned by the environmental impact of their supply chains, the reliability and punctuality of Arena deliveries are likely to be equally, if not more, important to them. If GNT’s key stakeholders have different interests in this way, then its own goals and objectives have to address these different aspects of performance.

Subsidiary company objectives – The interests of the different groups of external stakeholders also create difficulties for GNT in managing the performance of its subsidiary companies. Reliability and punctuality are clearly issues for both Oxford and Arena trains and so need to be reflected in the objectives and KPIs for both subsidiaries.

However, as Oxford services generate more revenue than Arena services (50% vs 40% of total revenue) this suggests that greater focus will be given to ensuring Oxford services run on time than Arena services. Equally, though, the suitability of a KPI measuring punctuality of Arena services could be reduced if Arena trains are delayed as a result of having to wait for Oxford trains to use a section of Steven in preference to them.

Tutorial note. Additional point about conflicting interests and objectives

If GNT focuses primarily on its Oxford services, and ensuring that these are on time, there is a danger that Arena services get overlooked within its portfolio. However, given that demand for Arena services has been increasing in recent years – due to congestion on the roads – Arena services could be a source of growth for GNT. Therefore, it could face a dilemma around how to achieve growth in its Arena services alongside maintaining punctuality levels for its Oxford services.

Measuring objectives

SMART objectives – Effective objectives should be ‘SMART’ – specific, measurable, attainable, relevant and time-bound.

GNT’s overall strategic objective does not exhibit a number of these characteristics. For example, instead of ‘continuing to reduce’ its level of carbon emissions, GNT’s objective would be more specific and measurable if it sought to ‘reduce carbon emissions by 5% each year’.

Selecting performance measures – For GNT’s performance measurement system to be effective, the aspects of performance which are measured (the KPIs) should be linked directly to GNT’s critical success factors and, in turn, to its overall strategic and financial objectives.

However, the difficulties we have identified in relation to setting objectives could also create difficulties in terms of performance measurement.

In particular, if GNT is struggling to decide what its performance priorities are, it may end up measuring performance in too many areas (rather than concentrating only on the key performance indicators). If GNT’s managers and the board become overloaded with information, this could actually reduce their ability to assess GNT’s performance and make strategic decisions effectively.

Objectives and controllability – It appears that there is only a single strategic objective for GNT as a whole, rather than there being strategic objectives for the three subsidiary companies as well. However, each of the individual companies has its own KPIs.

This situation could create problems in relation to controllability. For example, one of Arena’s KPIs is the proportion of trains arriving at their destination on time. However, if there is a signal failure (Steven’s responsibility), Arena’s punctuality performance will suffer, even though the cause of any delays is outside its control. Equally, as we have already mentioned, Arena trains could be delayed by Oxford trains, if they are given priority on the rail network.

Stakeholder influence – There could also be a danger that the aspects of its performance which GNT chooses to prioritise will be influenced disproportionately by interests of the stakeholders which hold the greatest power. For example, if GNT considers the Government to be its most important stakeholder, it could focus on the objectives and performance measures which are most important to the Government, potentially at the expense of the interests of other stakeholders such as customers, or its staff.

This kind of prioritisation of objectives could create problems for GNT, though. For example, a focus on cost effectiveness (to please the Government) may lead to under-investment in new trains. But as GNT’s trains (particularly its diesel engines) become increasingly old and unreliable, customers may feel their objectives are not being met. In turn this could lead to them seeking alternative modes of transport and GNT losing customers as a result.

This situation again reflects the problems associated with identifying GNT’s key strategic objectives. GNT’s performance measures need to be selected to help ensure it meets its key performance objectives. However, if GNT has a number of (potentially conflicting) performance objectives, then the process of selecting performance measures also becomes much more difficult.

Measurement vs management – Whilst GNT can measure factors such as punctuality or safety, these measures by themselves provide relatively little insight into the factors determining performance levels. For example, Arena’s punctuality figures could be affected by a number of different factors. Similarly, assessing the safety of the rail network in GNT is likely to be far more complex than simply measuring the number of signals passed at danger.

Therefore, while individual aspects of performance can be measured, a range of factors all need to be considered before any actions are taken to improve individual aspects of performance.

Context of performance reporting – In an integrated report, GNT will still report on its financial and operational performance, as it currently does, but the report should make clear to readers the extent to which GNT has achieved its strategic objectives. For example, as well as reporting its KPIs for punctuality, the report should highlight the extent to which GNT has achieved its objectives in relation to the reliability and punctuality of its services.

Importantly, in an integrated report, GNT will also report on social and environmental aspects of its performance. Currently, there appears to be little emphasis in GNT’s performance management and reporting on the way it manages and develops its ‘human capital’ (staff). However, as human capital is one of the six categories of capital identified within the integrated reporting framework, this should encourage GNT to evaluate the contribution of its people to its performance.

 Impacts on different categories of capital – More generally, performance reporting within an integrated report should explain the outcomes of an organisation’s performance in terms of six categories of capital: financial; manufactured; intellectual; human; social and relationship; and natural. Using these six categories could provide GNT with a framework for analysing its performance; for example, ‘manufactured’ capital could relate to Steven work and station upgrades, while ‘social and relationship’ capital could relate to improving customer satisfaction or customer loyalty.

However, the ‘integrated’ nature of the reporting also means that in its report GNT should highlight the interrelatedness and dependencies between different factors which affect its ability to create value over time. For example, investing in new engines (manufactured capital) should help to improve performance reliability and reduce pollution (natural capital), but these benefits will come at the financial cost of acquiring the new engines.

Importantly though, one of the key aims of integrated reporting is to reflect the longer-term consequences of the decisions organisations make, in order that they make more sustainable decisions. So, in its integrated report, GNT would be able to highlight the longer-term benefits of investing in the new engines.

Future strategy and outlook – The current annual report appears to focus on GNT’s financial and operational performance in the last year. In this respect, it is a backward-looking report. However, an integrated report would provide greater focus on future strategy and outlook.

In an integrated report, GNT would provide not only a summary of past performance but also a summary of how the organisation’s strategy, governance and performance can lead to the creation of value in the future – in both the short and the long term; for example, how the investment in new trains or new Stevens can help GNT provide an improved service to its customers.

Opportunities and risk – By focusing on its own financial and operational performance, there is a danger that GNT’s current report may become inward-looking. However, in an integrated report it would also highlight the opportunities and risks which affect its ability to create value, and how it is dealing with them. Although GNT has a monopoly over rail services in Pinland, it competes directly against road transport for both Oxford and Arena services. So, for example, GNT should use its integrated report to explain how it plans to use increasing road congestion as an opportunity to promote rail travel as a substitute for road travel.

Equally, however, GNT needs to consider the risks and threats to its business model. Even though the current Minister of Transport and the Rail Regulator oppose privatisation, this could change if a new government was elected in Pinland. However, one way to increase GNT’s resilience to any threat of privatisation is to demonstrate the value it currently creates, and thereby to highlight to any future governments that keeping the rail network under national control remains the best way to create value from it.

Amount of information – The board’s scepticism towards integrated reporting appears, at least in part, to come from its concerns about the extra cost and effort involved in producing an integrated report.

However, integrated reporting does not necessarily entail producing more information, and one of the potential benefits of integrated reporting is that it encourages organisations to produce shorter, more streamlined communications, rather than longer reports.

Instead of focusing on the quantity of information provided, the focus in integrated reporting is more about changing the way information is presented.

For example, instead of presenting information about GNT’s commercial, social and environmental performance in distinct ‘siloes’, integrated reporting would seek to highlight the connections between these different elements. In this way integrated reporting aims to provide stakeholders with a more holistic understanding of an organisation and its performance.

Therefore, rather than requiring the Management Accountant to prepare lots more information, the change to integrated reporting may be more likely to require the Management Accountant (and members of GNT’s senior management) to consider how different performance measures and indicators relate to each other.

Stakeholder interests – However, integrated reporting also seeks to respond to stakeholder interests by providing them with the information they want about the performance and direction of an organisation. As we have seen in part (a), there are a number of stakeholders with an interest in GNT and, if each of them want information about different aspects of performance, there is a danger that this could end up creating information overload in the report.

As part of its preparations for producing an integrated report, GNT could introduce a stakeholder engagement process with key stakeholders to identify what they want to know about the performance and direction of the organisation.

Additionally, the Management Accountant (in conjunction with the management team at GNT) will need to decide what data is most appropriate to collect, as well as what data it is possible to collect given the management information systems currently in operation at GNT.

Type of information

Reporting or focusing on strategy – An important theme in successfully applying integrated reporting is that it is not simply about reporting for its own sake, but that the information being reported needs to focus on an organisation’s core strategy.

From the examples given in the scenario, it seems that the KPIs which GNT already monitors are linked to its key objectives. If this is the case, then again integrated reporting should not require the Group Management Accountant to produce additional performance measures. However, rather than simply preparing the figures the Management Accountant would be expected to highlight the significance of the figures, and how they are affecting GNT’s ability to create value.

Non-financial KPIs – Another important benefit of integrated reporting is that it helps organisations to make clearer links between financial and non-financial performance.

By focusing on value generation in its broadest sense (rather than, for example, narrower goals of revenue generation) integrated reporting will also encourage organisations to review the set of performance measures they use. One of the main consequences of integrated reporting is likely to be the increased use of non-financial data to gain a clearer picture of an organisation and its performance.

In this case, however, it seems that a number of GNT’s KPIs are already non-financial, suggesting that GNT already appreciates the link between non-financial and financial performance. This again suggests that introducing integrated reporting may not require the introduction of many additional KPIs, although some may be required in relation to ‘human capital’ if this is not already covered by any of the existing KPIs.

Issues

Nonetheless, the increased importance on non-financial information could produce a number of issues for the Group Management Accountant:

• Can GNT’s current management information systems supply the full range of non-financial data which stakeholders would wish to see in an integrated report?
• If the data cannot be obtained from GNT’s current systems, how can the Management Accountant obtain the information?
• More generally, can non-financial information be gathered and verified within financial reporting timelines?
• How can the accountant ensure the information is reliable and, more generally, what assurance is there over non-financial data in the report? (Non-financial data is typically not audited in the same way that financial data is; but if stakeholders are going to rely on this data, then GNT should consider obtaining some kind of ‘assurance’ over the data.)

Tutorial note. Additional potential issues facing the Management Accountant

Integrated reporting is not yet mandatory, and there are currently no standard formats for producing integrated reports. Therefore a significant practical issue the accountant will face when producing GNT’s first integrated report will be to decide what information to include in the report and how to present it.

If the management accountant has to develop and produce the integrated report in addition to their existing work, this means the accountant will have less time available for that existing work. As a result, there is a danger management reports could be delayed, or the quality of them could be reduced – particularly in the short term, following the introduction of integrated reporting.

Relevant

For the external information to be useful, it should be relevant to the needs of the users. The information in the quarterly spreadsheet contains both sales data and information on market trends in designs. All of this information may not be relevant for all of the departments to which it is circulated. For example, data on design trends may not be relevant to the production department using it to plan production capacity.

A unified database, integrating data from different sources, would make data more relevant to users by giving users only information and reports which are relevant to them and sharing data from all relevant departments. Users would not waste time interpreting data which is irrelevant to them.

Timely

For external information to be useful, it must be available when needed. This is particularly so in the fashion industry where designs change quickly and where competitors may offer short-term discounts. The external information at Zara is only sent at the end of each quarter, which is likely to be too infrequent in the fast moving industry in which Zara operates. Additionally, as the information is prepared by one staff member, there could be delays in producing it if they were on sick leave, for example.

A unified database would ensure that data was available instantly, especially if linked to retailers’ own systems’ real-time sales data. This should improve the speed of decision making.

Accurate

To be useful, information must be accurate. Entering large volumes of data into a complex spreadsheet is prone to error, as well as being time-consuming. Inaccurate data may lead to poor decision making. A unified database would process all data automatically with minimal human intervention, and would thus be less prone to inaccuracies. All departments would share identical data.

Communication

Though the spreadsheet of external information at least ensures that all departments have access to the same data, the large volume of data may be difficult to understand. Managers may be overloaded with data, much of which they do not need. A unified database would allow users access only to information which they need. This would be in an easy-to-use format, perhaps with the ability to drill down to more detailed information held in the database.

Emailing data to a large number of staff may mean that confidential or commercially sensitive information, such as on design trends, is shared with staff who do not require it. A unified database would restrict access to information, using passwords, only to staff who are authorised to receive it.

Cost

The cost of producing the external information should not exceed the benefits of doing so. Costs of the current system include not only the costs of employing the team to compile the information but also time spent collecting, processing or interpreting data which may be inaccurate, irrelevant or out of date.

Using a unified database would incur costs of buying, maintaining and developing the system, as well as staff training. An evaluation must be made whether these costs are justified by the benefits. Some adaptation of the existing system, such as increasing the frequency of reporting the information, or sending different sets of information to different departments, may be more cost effective.

Tutorial note

The use of the characteristics of good information is one way this answer can be structured. There are many other approaches which would be acceptable.

Problems of performance measurement

Measuring the performance of the joint venture may require Zara and Milad to share confidential information, which they may be unwilling to do. Zara’s innovative designs for children’s footwear and Milad’s knowledge of advanced production techniques are both likely to be commercially sensitive.

It is unclear exactly what is each of the parties’ contributions to the joint venture. Zara is providing innovative designs, and Milad is providing advanced manufacturing machinery and production techniques. As each party is providing different things to the joint venture, it may be hard to measure the contribution, to profit for example, from each party.

Zara and Milad will have their own information systems. These may be incompatible, or it may be difficult or costly to integrate them. Each party may measure or collect information in a different way, which will mean information used to measure the performance of the joint venture is not prepared on a consistent basis.

Problems of performance management

Zara’s objective for the venture is to become the market leader in high-quality children’s footwear. Milad’s objective is to utilise spare production capacity in a factory where the lease is due to expire in three years. As the parties have different objectives, it may be hard to develop performance metrics for the joint venture. The share of the chosen market may be a key performance metric for Zara, and return on capital employed may be appropriate for Milad. The metrics chosen may conflict, and their relative importance may be unclear. This will make it difficult for managers to manage the joint venture according to each party’s objectives.

Zara’s objectives for the joint venture are long term, whereas Milad may choose to end the joint venture upon expiry of the factory lease in just three years. Establishing timescales for performance objectives may be difficult as each party has different time horizons for the venture.

Zara is entering a new market and has already invested heavily in market research and product design. Milad seems to have a much lower risk appetite, as it only wants to utilise spare capacity. Managing performance may be difficult because Zara may wish to make decisions which involve a higher level of risk than Milad may wish to accept.

The parties have may have different expectations of the level of quality of products arising from the joint venture. Zara manufactures high-quality footwear and will want its range of children’s footwear to be of a quality consistent with its women’s footwear range. Milad supplies supermarkets and high street stores, probably with lower quality products. Disagreement about acceptable levels of quality may reduce the performance of the joint venture.

In its simplest form, integrated reporting can be understood as the merging of the sustainability report and the financial report into a single ‘narrative’, as described by the Marketing Director.

However, the International Integrated Reporting Council (IIRC) does not use the word ‘sustainability’ in its definition of the concept.

According to the IIRC’s ‘International IR Framework,’ an integrated report is ‘a concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term.’

The key emphasis of this definition is the idea of sustainable value creation, which makes the report and the processes underpinning it far more valuable than simply a compliance or reporting exercise.

Furthermore, this framework is intended as guidance for all businesses producing integrated reports, rather than compliance with a set of rules.

The IR Framework recognizes the importance of looking at financial and sustainability performance in an integrated way – one that emphasizes the relationships between what it identifies as the ‘six capitals’:

Financial capital

This is what we traditionally think of as ‘capital’ – e.g., shares, bonds or banknotes. It enables the other types of Capital described below to be owned and traded.

Manufactured capital

This form of capital can be described as comprising of material goods, or fixed assets which contribute to the production process rather than being the output itself – e.g. tools, machines and buildings.

Intellectual capital

This form of capital can be described as the value of a company or organisation’s employee knowledge, business training and any proprietary information that may provide the company with a competitive advantage.

Human capital

This can be described as consisting of people’s health, knowledge, skills and motivation. All these things are needed for productive work. Social capital This can be described as being concerned with the institutions that help maintain and develop human capital in partnership with others; e.g. Families, communities, businesses, trade unions, schools, and voluntary organisations.

Natural capital

This can be described as any stock or flow of energy and material within the environment that produces goods and services. It includes resources of a renewable and non-renewable materials e.g. Land, water, energy and those factors that absorb, neutralise or recycle wastes and processes – e.g. climate regulation, climate change, CO2 emissions.

The fundamental assumption of the IR Framework is that each of these types of capital—whether internal or external to the business, tangible or intangible— represents a potential source of value that must be managed for the long run in order to deliver sustainable value creation.

The objectives for integrated reporting include:

• To improve the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital
• To provide a more cohesive and efficient approach to corporate reporting that draws on different reporting strands and communicates the full range of factors that materially affect the ability of an organisation to create value over time
• To enhance accountability and stewardship for the broad base of capitals (financial, manufactured, intellectual, human, social and relationship, and natural) and promote understanding of their interdependencies
• To support integrated thinking, decision making and actions that focus on the creation of value over the short, medium and long term.

As well as external reporting to a range of stakeholders, the principles of IR can be extended to performance management systems. This is sometimes referred to as ‘internal integrated reporting’.

An emphasis on these types of capital could result in more focussed performance management in the following ways:

• KPIs can be set up for each of the six capitals, ensuring that each of the drivers of sustainable value creation are monitored, controlled and developed.
• These can be developed further to show how the KPIs connect with different capitals, interact with, and impact each other.
• The interaction and inter-connectedness of these indicators should then be reflected in greater integration and cooperation between different functions and operations within the firm.
• This should result in greater transparency of internal communications allowing departments to appreciate better the wider implications of their activities.
• Together this should result in better decision making and value creation over the longer term.

The branch information appears to be inadequate on a number of levels to appraise the shop manager’s performance. The manager should only be held responsible for those areas of performance that they can control.

The branch manager should be appraised on a realistic sales budget. The overall market fall of 12% suggests that the original budget of no change on previous year was not realistic. It is possible to analyse this by calculating planning and operational variances as follows:

The operational variance reflects more accurately the manager’s work and from this we can see the manager has done well by limiting the fall in gross profit by $1,812.

This analysis could be extended to other areas of the performance report. For example, if the breakdown of sales prices and volumes for individual product lines were given together with details of market volumes and price movements then the sales price variance could be broken down into operational and planning elements to reflect the manager’s use of the limited discounting power that she has. Overall at the Tunny branch, the gross margin has remained constant (at 60%) which indicates that the manager may not have made use of the sales price discounting authority.

There are a number of other non-controllable costs in the branch information. It is unlikely that the branch manager can affect the price variance of heating and lighting costs as the prices are set through central purchasing although they will have some control over usage. The rental cost will reflect head office property management and is not controllable. The manager’s own wages are not controllable although the staff costs will reflect the fact that the manager can choose to work longer hours and so save on part-time staff, therefore a labour efficiency variance would be appropriate.

A revised report would split the costs into two groups (controllable and oncontrollable) so that a controllable profit would be shown as well as the overall shop profit. This would be the basic measure of performance of the store. A more detailed understanding of responsibility for the variances would be given by a breakdown of the operational (controllable) and planning (non-controllable) elements of each variance.

It might look like this:

Revised performance report

Altair Chess Stores

Tunny branch – Year to Sept 2011

Notes:

Property costs includes heating, lighting and rental.

Positive variances are favourable.

Summary

The manager’s performance has been good in difficult general economic circumstances since if we exclude the gross margin planning variance ($19,152A) and allow that the part-time staff costs and marketing costs are controllable then we see that there is a favourable variance in controllable profit of $6,312 ($19,152- $12,840).

As indicated, additional variances that could be reported include operational and planning price variances for sales; part-time labour efficiency variances in operational variances; part-time labour rate variances in planning variances; and some price and usage variances for property costs. There is insufficient data to calculate examples of these variances here.

The management style at Altair is highly budget-constrained (Hopwood). It is driven by financial performance to meet the needs of the venture capitalist owners who have probably highly geared the business at the time of purchase. The cost control attitude is illustrated by the focus on achieving budget in the reward system and the enforcement of staff pay rates. This management style leads to stress for employees and difficult working relationships – as illustrated by the unhappiness of the shop managers. It also can motivate manipulation of performance reports although given the centralised nature of Altair this appears unlikely at the shop level. It does however focus attention on achieving budget. This could be desirable in difficult economic circumstances.

Alternative styles are:

• profit-conscious where the performance is evaluated on longer-term effectiveness of the business unit in question (plausible here given Altair’s aim of profit maximisation)
• non-accounting where the budget is of low importance in performance evaluation

The performance appraisal system at Altair reflects this cost-conscious, budget constrained approach. The shop managers are instructed as to their objectives and there appears to be no discussion of this target between the appraiser and the shop manager. For the branch given, it is striking that the failure to make budgeted profit (by $12,840) has led to no bonus being paid although the shop made an operating profit of $43,160 and the operating margin of the shop has held up at 18% compared to 21% per the budget.

The branch information needs to reflect the areas that the manager can control as mentioned in part (a) to this answer. Using the analysis of revised controllable profit, we have seen that the manager has returned a good performance $6,312 ahead of budget. The increased use of operational and planning variances should help to motivate the managers and reduce the friction with senior staff.

The current contract between the manager and Altair could be described as coercive as it is imposed. The budget should be agreed between the manager and their appraiser using the detailed knowledge of both parties to improve the budget estimates. Although for Altair, the likely budget will reflect the expectations of the senior management in order to achieve the business’ overall financial objectives.

The reward system could move to a more calculative basis where the manager is paid a percentage of the profit above a certain level, usually this bonus is capped to a maximum as in the current system. The senior management will need to assess the trigger level based on head office costs (administrative support and financing costs). Therefore, the operational director’s assessment would become more objective and this could remove lack of clarity in how performance is assessed.

Performance appraisal could also recognise longer-term and non-financial factors in the manager’s performance such as innovative marketing ideas and customer feedback on their shopping experience. Additionally, as the branch manager handles the shop’s staff development, recognition could be given for branch staff who progress from part-time to shop manager.