TaxTMI 
TaxTMI 
GUIDANCE NOTE ON PERFORMANCE APPRAISAL REPORT (Form-III ) - November, 2012
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.... the performance of the organization as a whole. Effective performance measures can let us: ♦ Monitor performance to judge how well the company is fairing, ♦ Know if company management is meeting its goals. ♦ If appropriate actions have been taken to affect performance or improve efficiency if improvements are necessary. There is no set number or formula to determine how many performance measures an organization should have. Tracking too many performance measures at once may cause managers to lose sight of which ones contribute directly to strategic objectives. On the other hand, having too few measures may not tell a good story about your work. Since the Performance Appraisal Report is to be submitted to the Board of Directors of the Company, the performance measures which will be appraised should be discussed with the Company Management and then finalized for analysis and reporting thereof. This guidance is not on strategic management in companies but using strategic management process in the context of performance analysis of companies under Cost Audit provisions of the Companies Act, 1956. The guidance note is al....
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....earnestly requested to send their responses, to the Institute for larger benefits. 2. PERFORMANCE ANALYSIS: The rationale of Performance Appraisal Report (PAR) 2.1 The basic objective of Performance Appraisal Report is to provide an actionable insight into costs and profitability for the management in the strategic and operational context. It aims at discovering various drivers of costs and profitability and their impact on the selected performance variables. It would help the organisations: ♦ to improve profits and profitability ♦ to optimize resource allocation ♦ to optimize the product and services portfolio 2.2 The Performance Appraisal Report is to be provided only to the company under cost audit. The form III is NOT to be submitted to anyone else. In that sense, this report is a confidential and not public document. According to the rule 4 (5) of the Companies (Cost Audit Report) Rules 2011, the Performance Appraisal Report should be submitted to the Board or Audit Committee of the Board of the company. 2.3 The objective is to provide the management objective assessment of the performance of the organi....
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....hat the Performance Appraisal Report is meant to be used by the company and this report is confidential. 4.2 The report, being an annexure to the cost audit report, should basically lay more thrust on the cost management aspect of the business and should effectively bring out comments on how the business performance could be improved by elevating the cost performance. 4.3 When commenting on or analyzing the cost performance, the cost auditor could assess the impact of changes in the costs on the profitability of the products, profitability by customers or market segments. 4.4 The cost drivers that are the fulcrum of the cause and effect relationship in the cost statement, are the ones which form the first level of KPIs that are easily understood and actionable for the operational executives. The cost auditor while evaluating the KPIs can also look at the efficacy of the cost drivers. This evaluation will also enable the operational executives to relate what is being done at the shop floor to the cost statements that are the end product of the cost accounting system. 4.5 It would be necessary to analyze the use of various resources to boost economy, efficiency and effect....
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....follows: 5.2 In the above paragraphs, we discussed how the strategies are formulated, how they are implemented through the processes and now we come to assess the actual performance. Performance measures tell managers something important about the company's products, services, and the processes. Effective performance measures can let us: ♦ Monitor performance to judge how well the company is doing, ♦ Know if company is meeting its own set goals and if the customers are satisfied, ♦ Take action to affect performance or improve efficiency if improvements are necessary. So we need to identify appropriate Performance measures so that the analyst is provided data and information necessary to make informed decisions. Performance measures provide a snapshot of current performance capabilities and track whether actual performance is getting better, staying the same, or getting worse over time. Machine hour rate is a performance measure which provides us inputs for various decisions. Capital expenditures tell about the investment of funds; we communicate the return on that investment through performance measures. 5.3 K....
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....the Management of the company to apprise them of the scope of Form III of the Companies (Cost Audit Report) Rules 2011, with specific reference to the company. 6.1 Identify and understand the key strategies of the company, both prescriptive and emergent strategies included. 6.2 Choose strategies that have more visible expressions in costs data maintained by the company. 6.3 Identify the activities that were impacted by the strategies selected and also implemented during the year of cost audit. 6.4 Analyze the cost implications of those activities and link it with the expected results of the strategies. 6.5 Present the evaluation, in a table or any other easily comprehensible format like histogram, chart, graph etc. 6.6 Give explanatory notes for the terms used, calculations made, and assumption behind the evaluations. 6.7 Finalize the finding after a discussion with the concerned operating executives and then with the management of the company. 7. General Guidance on the first time preparation of Performance Appraisal Report 7.1 The Performance Appraisal Report being the part and parcel of the cost audit report, it would apply in all the cases where Compa....
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....n-financial performance indicators. The selection of Key performance indicators (KPIs) for a highly diversified company may be difficult and should be done based on the economic relevance of each business in the overall performance. ♦ It would be better to provide the comparative figures for the previous one or two years as may be required in consultation with the management. The preparation time for the first report may be a little longer as the information may have to be collected and analysed for more than one reporting period. ♦ The cost auditor could summarize the plan in order to have clarity. A suggestive format of the plan is given in the Appendix- A 7.3 Once the terms of Performance Appraisal Report are agreed upon as above, the cost auditor should ensure that the company has the underlying information system which could throw up the data required for the preparation of Performance Appraisal Report. In case, the existing system is insufficient, the cost auditor could hold discussions with the IT head of the company. 7.4 The cost auditor is recommended to have a personal hearing from the head or member of the audit company and d....
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....uld choose to continue reporting on the same parameters or may elect to alter some of them in consultation with the management. 8.3 For every subsequent year, it is necessary to question the basis of preparing and submitting the Performance Appraisal Report. If substantial changes have occurred in the business during the year (like merger or demerger, introduction of a new products, new markets, discontinuation of a product line, new technological development, or such other material changes), the cost auditor should make suitable changes in the contents and format of the Performance Appraisal Report. 8.4 It would be pertinent to highlight the effect of such changes on the overall performance of an organisation and also how these factors could potentially drive the future performance of the company. 8.5 The cost auditor should comment on the feedback on the previous year's Performance Appraisal Report. There may suggestion made in the previous year on which the management may have agreed to act upon. The Performance Appraisal Report should comment on the actions taken by the management and the outcome thereof. This is essential to ensure no issue remains open. 8.6 Th....
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....nalysis (ii) Productivity/Efficiency Analysis (iii) Utilities/Energy Efficiency Analysis (iv) Key-Costs & Contribution Analysis (v) Product/Service Profitability Analysis (vi) Market/Customer Profitability Analysis (vii) Working Capital & Inventory Management Analysis (viii) Manpower Analysis (ix) Impact of IFRS on the Cost Structure, Cash-Flows and Profitability (x) Application of Management Accounting Tools 9.7 For these and any other performance measures elected for inclusion in the Performance Appraisal Report, the cost auditor should also include wherever appropriate the following: ♦ Horizontal and vertical analysis of quantitative figures ♦ Trend analysis of performance parameters reflecting 3-10 years' figures ♦ Qualitative comments with interpretations of the cost auditor ♦ Comparison with external benchmarks such as industry average 10. Capacity Utilisation Analysis 10.1 The basic quantitative information on capacity is covered in the Para 4 - Quantitative I....
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.... on costs ♦ Ability to serve markets by creating short term capacity ♦ Analysis of throughput per hour of constraint capacity resource and return per hour at this resource (could be done decomposing the Throughput Accounting ratios) ♦ Committed capacity costs by process and managed capacity costs by process ♦ Impact of wastages on capacity utilisation 10.9 The cost auditor's checklist would include processing of information gathered from sources like: ♦ Technical documents pertaining to the equipment ♦ Production planning reports ♦ Interviews with managers responsible ♦ Wastage and down-time reports ♦ Benchmarking exercises done, if any ♦ External sources providing suggestive capacity reporting formats like CAM-I publications (Consortium for Advanced Manufacturing - International) 10.10. Suggested additional references ♦ Cost Accounting Standard (CAS- 2) - Capacity Determination issued by the Institute of Cost Accountants of India ♦ CAM....
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....put * Achieve slightly less output with much less input ♦ For each selected area, the cost auditor should identify whether the improvement is permanent or temporary and report on the same. The recommended approach for the organisation should be focusing on the sustainable improvements. Care should be taken to identify and report potential manipulations. ♦ Alongside the productivity or efficiency ratios, the cost auditor should also analyse and report on the effect of the same on quality. The cost auditor should isolate quality of various inputs and their effect of the output. ♦ The performance measures in respect of this area could be: * Inputs ustilised (material, man, machine, capital etc) per unit of output or output obtained per unit of an input variable * Wastages as percentage of input * Indices could be developed for Single Factor Productivity (SFP), Multi-Factor Productivity (MFP), Total Factor Productivity (TFT) * Inter-relationships in various productivity measures e.g. output per man-hour may have increase, but if it is accompanied by higher w....
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....ers, etc. 12.5 For external benchmarking, it may be useful to refer to the practices followed by companies which are accredited by the Bureau of Energy Efficiency formed under the Energy Conservation Act 2001. 12.6 The performance appraisal parameters for energy and utilities would include the consumption of fuel for generating energy and then the use of the energy thus produced per unit of final product. The performance parameters could include the following: ♦ Energy generated per unit of fuel consumed or fuel consumed per unit of energy generated. This could be applied for power, steam, electricity, water etc. ♦ Measurement of improvement in power factor (denoting reduction in the KVA demand charges) ♦ The cost of generating energy per unit and the cost of consuming the energy per unit of the finished product would be the critical part of the analysis. ♦ Trend analysis of energy costs as percentage of total production costs is a good indicator of performance 13. Key Costs And Contribution Analysis 13.1 The thrust here should not be only on computation of numbers or percentages for various....
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....ng, accepting or rejecting an order, make or buy etc. 13.8 The checklist for the cost auditor could include reference to ♦ Sales and production records ♦ Reconciliation with CENVAT records ♦ Price lists and discount structure policy ♦ Product cost statements ♦ Operational budgets 14. Product/Service Profitability Analysis 14.1 The unit product or service profits are driven by two major components viz. cost per unit and selling price per unit. The cost auditor should analyse if the business belongs to the sellers' market or buyers' market. This would facilitate the assessment of impact of changes in selling prices and changes in costs on the profitability or otherwise of the products or services. While the selling price is a single number, the cost is the sum total of different elements. The cost auditor must ensure that the basis use to allocate indirect costs is consistently adopted by the company. 14.2 In case of services, the unit of measurement is very important and hence carefully selected. Further, due to the diverse nature of services, it is essential to ex....
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....st statements ♦ Operational budgets 15. Market/Customer Profitability 15.1 Certain industries focus on limited markets and customer types, while the others are broad based. The management may choose to understand its position in the different markets and different customers it serves. 15.2 The cost auditor should observe the segmentation method adopted by the company for analysing its profitability. The objective is to take suitable action for the segments that are not performing as per desired targets by introducing campaigns or to pull out of those segments that are no longer attractive. 15.3 The markets could be segmented on the basis of geographical locations such as domestic & international, zones or regions. They can also be segmented based on customers, e.g. OEMs, institutional, dealers, aftermarket, retail etc. These are normally termed as channels of distribution. Sales and supplies to Government, related parties could also be used for analysis. 15.4 The challenge in all the above named method of segmentation lies in the computation of costs for each of them. The cost auditor should carefully evaluate the allocation of costs to the differ....
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....ts of working capital. The cost auditor should identify all the elements of working capital for each product group and evaluate the adequacy or otherwise thereof. 16.2 In case of multi-unit operations, the working capital and inventory management is centralized, with sub limits fixed for each manufacturing locations. While the working capital assessment is done for the Company as a whole, the key factor which influences the working capital requirement of each unit have to be kept in mind and evaluated. 16.3 On the whole, the cost auditor should critically examine the working capital policy of the company. The total working capital could be analysed into permanent and fluctuating components. It is necessary to check whether the funding of these components is consistent with the period of requirement. 16.4 Working capital decision is handling of the conflict between liquidity and profitability. The cost auditor could provide an independent assessment of how it is being currently handled and how it can be improved. 16.5 The analysis of working capital can be done using the traditional measures of ratios like current ratio, quick ratio, turnover ratios, number of days in op....
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.... be explicit or implicit. Reasonable assumptions could be made for computing the implicit costs. The total cost of managing working capital as a percentage of total working capital invested may be a very useful performance indicator. 16.12 The cost auditor's checklist could include the reference to the following: ♦ Records related to inventory of RM, WIP and FG, stock discrepancy reports ♦ Inventory aging reports, reports on treatment of non-moving items ♦ Reports on receivables - aging, timely collection, bad debt etc. ♦ Terms and conditions of working capital funds such as bank credit, loans etc. 17. Manpower Analysis 17.1 The depth of analysis of manpower could depend upon the proportion of manpower cost to the total cost of product or service. The performance criteria for this area will mainly be related to the costs and efficiency or productivity. Again, benchmarking with the similar organisations would be helpful. 17.2 The costs may be categorized into the cost of recruitment, cost of maintaining the manpower and the cost of separations. Recruitments costs may include position adve....
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....r should get acquainted with the requirements of the new standards and the differences as compared to the existing standards. 18.3 In the Performance Appraisal Report, the cost auditor may point out the impact of IFRS on the existing cost structure, cash flows, and profitability. It may be noted that the new standards provide a principle based framework in place of rule based standards, and as such the companies may need to assess the effect of their actions and choices made for accounting. 18.4 The five main elements of financial statements are assets, liabilities, equity, income and expenses. The IFRS provide for recognition, measurement and disclosure criteria for these elements. In cases, where the measurement criteria change, there will be an impact on the costs. The changed recognition criteria may impact the profitability and cash flows of the company. 18.5 The most important effect on valuation will happen through the adoption of "fair value" concept in measuring various assets and liabilities. The cost auditor must enumerate the cases where use of fair value is mandatory or permitted as management's choice. It should be noted that any change in the fair value ....
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....e comments of the potential changes for the understanding of the Board and Audit Committee members. The cost auditor could provide them an insight to the likely changes in the cost structure. This content area is an important aspect to be covered till the new standards are not adopted. In subsequent years, it may lose its relevance. 19. Other areas that could be covered in the Performance Appraisal Report 19.1 As stated in the note to the form III, the above named areas are only indicative. It should, however, be noted that these are very comprehensive and could cover most of the aspects of enterprise performance. However, depending upon the specific characteristics of the industry within which a company operates, the performance criteria should be chosen and included in the Performance Appraisal Report. It may be necessary to drop one or more of the above on the basis of their relative importance (or the lack of it) for the organisation. 19.2 Some additional areas of performance assessment actually may not directly comment upon the current or past performance but the likely future performance. The cost auditor should make use of the non-financial measures of performance t....
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....nt performance area. The cost auditor could include analysis of quality performance of the company. The quality performance could be assessed by relating the quality costs incurred versus the benefits achieved by reduction in customer complaints or increase in customer satisfaction index. The quality costs should be reported as prevention costs, appraisal costs, internal failure costs and external failure costs. It will be useful to analyse the changes in the composition of total quality costs and their impact on the sales and profits, e.g. higher spending on prevention would mean less costs on external failures, which in turn would reduce customer complaints and could bring in higher sales. Such analysis would provide good value for the user of the Performance Appraisal Report. 19.8 R & D Performance: The future performance of companies would depend upon their success of the R & D initiatives. The cost auditor could provide a useful lead in this respect by including analysis of the R & D costs. The analysis may include, inter alia, the percentage of successful research initiatives, the turnaround time taken for development, the response time taken for changes in designs due to ....
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....ould be denoted by EPS growth, the stock price performance, market capitalization, dividend growth, EVA etc. The lenders' parameters would be interest coverage and debt-service cover ratios. The suppliers would look for business growth, and on time payments. Customers expect on time delivery, proper pre and post sales service, and reasonable prices. These are performance metrics could be included in the Performance Appraisal Report. 20. Management Accounting tools 20.1 The performance measurement involves collection of information, analysing the same by establishing the inter-relations between them, interpreting the results and then arriving at meaningful conclusion. The collection of information depends upon various sources of data and other reports for various systems used by the organisation. 20.2 The data input is generally made in the accounting system used by the company e.g. the ERP systems. Most of the ERP systems facilitate input and capturing of even the non-financial data which can be then processed to produce desired reports. There is a lot of information to be accessed from outside of the ERP system. The cost auditor should identify such sources within and....
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....riod of time to observe whether they are improving or not At the outset, based on the initial discussion with the management, a proper checklist may be drawn in the following format for planning the Performance Appraisal Report: KPI (performance measure) Also indicate if strategic or operational Type of KPI (whether quantitative or qualitative) Functional areas affected by KPI Persons/ departments responsible Measurement criteria Comparison with (budget, standard, external benchmark etc) Depending upon merit of each case, the cost auditor could factor in other things such as source of the information, measurement frequency, time periods to be covered, etc. This will facilitate clarity of understanding and once the cost auditor gets the management's nod on these basic elements, the Performance Appraisal Report c....
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.... Overall Order-to-cash cycle days Supplier performance Delivery On time supplies Supply of full quantity Quality % of rejections Cost Price reductions agreed - cost effect Price escalations given - cost effect Overall Supplier satisfaction index Accuracy of forecasts shared APPENDIX C Additional references for cost auditor 1. Annual reports of the companies for current year and past years 2. Guidance given by companies to stock markets 3. Written Policy documents of the company 4. Company web-sites 5. Web-sites of industry associations 6. Macro-economic data from RBI, Ministry of finance and commerce & industry etc. 7. Management accounting tools and techniques - reference books and hand books 8. Cost accounting standards issued by the ICAI 9. Accounting standards and Ind AS issued by the Institute of Chartered Accountants of India 10. Generally accepted cost accounting principles (CAGAP) published by ICAI 11. Stock market information on prices, market capitalisation, market retu....
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....n, not losing the sight of other implications. Familiarity with the strategic management process will be an essential requisite for this focus. 1.2 Strategic Management Process: Strategy and strategic management are significant aspects of company's decision making process in a specific political and cultural context and the performance analysis would include a rational assessment of the strategies and implementation thereof. However, the Para III of the Cost Audit Report Rules, 2011, would also deal with those aspects of company's performance which have cost implications in a strategic context. While it is true that the notifications of June 3, 2011, prescribing Para III, do not restrict to operational performance analysis with cost implications only, this guidance note is based on the premise that the Cost Auditor's role in performance appraisal report can be extended to strategic areas expressible in terms of cost impacts. There is a sufficient scope for reporting on overall performance, because of the recent thrusts in companies on resource-led strategies which tend to have significant cost implications. 1.3 Strategic Management is concerned with: &nbs....
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....is is a good example to appreciate the meaning of physical resources' performance. Input-output ratio, machine hour rate are some of the factors that may throw light on the usage of physical resources. (b) Human Resources: Skill base of this resource, under each category, its conformity with the strategies are important areas of analysis and evaluation. Similarly, the adaptability of the human resources to the strategies formulated, needs to be examined while evaluating the operational processes as well as their outcomes. (c) Financial Resources: Financial Resources are the money available to a business for spending in the form of cash, liquid securities and credit lines. Simply put Financial Resources represent the money that is available for a person or organization to spend. Before going into business, an entrepreneur needs to secure sufficient financial resources in order to be able to operate efficiently and sufficiently well to promote success Companies often need funding for starting or continuing business operations. Small businesses typically need start-up funds, while medium and larger companies may need funding to expand operations or purchase competitors....
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....in identifying the core competencies (those that are unique to the company) of the company and their comparisons through appropriate benchmarks. This is an area of professional expertise of the cost auditor. Core competencies (cost efficiency being an important one) in different activities contribute to the competitive advantage of the company. Identifying the core competence of the company in various activities/cost centres and providing performance appraisal of them, periodically, is within the scope of the Performance Appraisal Report. Creating and managing these core competencies provides leverage and levels of performance that are difficult to imitate by competitors, and hence the competitive advantage to the company. 1.7 Value Chain: It needs to be appreciated that many company attempts to gain competitive advantage by appropriately linking its own activities with those of the suppliers, channels or customers. Vertical-integration, quality controls on inputs from suppliers, total quality management strategies, controlling distributors' performance through training/financing etc., collaborative arrangements etc. are some of the ways in which company's own acti....
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....dividual activities, group of activities, processes, outcomes including final products/services. 2. PROCESS MAPPING AS A TOOL IN PERFORMANCE MANAGEMENT AND EVALUATION. 2.1 Definition of "process": "A collection of interrelated work tasks, Initiated in response to an event." The objective of a process is to achieve the specific result as expected by its customer. A process can be made up of processes, often called sub-processes. Process mapping is to understand the activities of the company, in the background of strategies formulated and implemented by the company at all levels. To evaluate performance it is necessary to understand the processes in the company, as they constitute the area of performance analysis. Each process is understood by what is known as process mapping. Processes involve more than one person/equipment, coordinated effort is required. Tasks involve one person/equipment. Two versions of a process map are common: > As-is: the current state of the process; > To -be: the goal state of the process; 2.2 Likely results of process mapping: Increased understanding of process, Increase consensus about the process, increased visibility into the process (....