Problem 1 -
Cindy Jones, Controller of Systematic Designs, believes that effective budgeting greatly assists in meeting the organizations goals and objectives. She argues that the budget serves as a blueprint for the operating activities during each reporting period, making it an important control device. She believes that sound management evaluations can be based on the comparisons of performance and budgetary schedules and that employees respond more favorably when they participate in the budgetary process. Kevin Dobbs, treasurer of Systematic Designs, agrees that budgeting is essential for overall organization success, but he argues that human resources are too valuable to spend much time planning and preparing the budgetary process. He things that the roles people play in budgetary preparation are not important in the final analysis of a budgets effectiveness.
Required - Contrast the participative versus imposed budgeting concepts and indicate how the ideas of Jones and Dobbs fit the two categories.
Problem 2 - Behavioral Considerations and Budgeting
Anthony Wagner, the controller in the Division of Transportation for the state, recognizes the importance of the budgetary process for planning, control, and motivation purposes. He believes that a properly implemented participative budgeting process for planning purposes and a management by exception reporting procedures based on that budget will motivate his subordinates to improve productivity within their particular departments. Based on this philosophy, Wagner has implemented the following budget procedures.
An appropriation target figure is given to each department manager. This amount is the maximum funding that each department can expect to receive in the next fiscal year.
Department managers develop their individual budgets within the following spending constraints as directed by the controller's staff.
1. Expenditure requests cannot exceed the appropriation target
2. All fixed expenditures should be included in the budget; these should include items such as contracts and salaries at current levels.
3. All government projects directed by higher authority should be included in the budget in their entirety
The controller consolidates the departmental budget requests from the various departments into one budget that is to be submitted for the entire division
Upon final budget approval by the legislature, the controller's staff allocates the appropriation to the various departments on instructions from the division manager. However, a specified percentage of each department's appropriation is held back in anticipation of potential budget cuts and special funding needs. The amount and use of this contingency fund are left to the discretion of the division manager.
Each department is allowed to adjust its budget when necessary to operate within the reduced appropriation level. However, as stated in the original directive, specific projects authorized by higher authority must remain intact.
The final budget is used as the basis of control for a management by exception form of reporting. Excessive expenditures by account for each department are highlighted on a monthly basis. Department managers are expected to account for all expenditures over budget. Fiscal responsibility is an important factor in the overall performance evaluation of department managers.
Wagner believes that his policy of allowing the department managers to participate in the budget process and then holding them accountable for the performance is essential, especially during these times of limited resources. He also believes that department managers will be positively motivated to increase the efficiency and effectiveness of their departments because they have provided input into the initial budgetary process and are required to justify any unfavorable performances.
Required
a. Explain the operational and behavioral benefits that generally are attributed to a participative budgeting process.
b. Identify deficiencies in Wagner's participative budgetary policy for planning and performance evaluation purposes. For each deficiency identified, recommend how the deficiency can be corrected.
Problem 3 - Budgetary Slack with Ethical Consideration
Karen Bailey was promoted department manager of a production unit in Parkway industries three years ago. She enjoys her job except for the evaluation measures that are based on the department's budget. After three years of consistently poor annual evaluations based on a set annual budget, she has decided to improve the evaluation situation. At a recent budget meeting of junior-level managers, the topic of budgetary slack was discussed as a means to maintain some consistency in budgeting matters.
As a result of this meeting, Bailey decided to take the following steps in preparing the upcoming year's budget:
1. Use the top quartile for all wage and salary categories.
2. Select the optimistic values for the estimated production ranges for the coming year. These are provided by the marketing department.
3. Use the average of the three months in the current year with poorest production efficiency as benchmarks of success for the coming year.
4. Base equipment charges (primarily depreciation) on replacement values furnished by the purchasing department.
5. Base other fixed costs on current cost plus an inflation rate estimated for the coming year.
6. Use the average of the ten newly hired employee's performance as a basis of labor efficiency for the coming year.
Required
a. For each item on Bailey's list, explain whether it will create budgetary slack. Use numerical examples as necessary to illustrate.
b. Given the company's use of static budgets as one of the performance evaluation measures of its managers, can the managers justify the use of built-in budgetary slack?
c. What would you recommend as a means for Bailey to improve the budgeting situation in the company?
Provide some specific examples of how the budgeting process might be improved.
Problem 4 - Causes of Standard Cost Variances (Comprehensive)
Following are ten unrelated situations that would ordinarily be expected to affect one or more standard cost variances.
Answer
1. A salaried production supervisor is given a raise, but no adjustment is made in the labor cost standards.
2. The martials purchasing manager gets a special reduced price on raw materials by purchasing a train carload. A warehouse had to be rented to accommodate the unusually large amount of raw materials. The rental fee was charged to Rent Expense, a fixed overhead item.
3. An unusually hot August caused the company to use 25,000 kilowatts more electricity than provided for in the variable overhead standards.
4. The local electric company raised the charge per kilowatt-hour. No adjustment was made in the variable overhead standards.
5. The plant manager traded in his leased company car for anew one in July, increasing the monthly lease payment by $150.
6. A machine malfunction on the assembly line (caused by using cheap and inferior raw materials) resulted in decreased output by the machine operator and a higher than normal machine repair costs. Repairs are treated as variable overhead costs.
7. The production maintenance supervisor decreased routine maintenance checks, resulting in lower maintenance costs and lower machine production output per hour. Maintenance costs are treated as fixed costs.
8. An announcement that vacation benefits had been increased resulted in improved employee morale. Consequently, raw martials pilferage and waste declined, and production efficiency increased.
9. The plant manager reclassified her secretary to administrative assistant and gave him an increase in salary.
10. A union contract agreement calling for an immediate 5 percent increase in production worker wages was signed. No changes were made in the standards.
Required - For each of these situations, indicate by letter which of the following standard costs variances would be affected. More than one variance will be affected in some cases.
a. martials price variance
b. Materials quantity variance
c. Labor rate variance
d. Labor efficiency variance
e. Variable overhead spending variance
f. Variable overhead efficiency variance
g. Fixed overhead budget variance.
Problem 5 - Behavioral Effect of Standard Costs
Merit Inc. has used a standard cost system for evaluating the performance of its responsibility center managers for three years. Top management believes that standard costing has not produced the cost savings or increases in productivity and profits promised by the accounting department. Large unfavorable variances are consistently reported for most cost categories, and employee morale has fallen since the system was installed. To help pinpoint the problem with the system, top management asked for separate evaluations of the system by the plant manager, controller, and the human resources director. Their responses are summarized here:
Plant Manager - The standards are unrealistic. They assume an ideal work environment that does not allow materials defects or errors by the workers or machines. Consequently, morale has gone down and productivity has declined. Standards should be based on expected actual prices and recent past averages for efficiency. Thus, if we improve over the past, we receive a favorable variance.
Controller - The goal of accounting reports is to measure performance against an absolute standard and the best approximation of that standard is ideal conditions. Cost standards should be comparable to "par" on a golf course. Just as the game of golf uses a handicap system to allow for difference in individual players' skills and scores, it could be necessary for management to interpret variances based on the circumstances that produced the variances. Accordingly, in one case, a given unfavorable variance could represent poor performance, in another case it could represent a good performance. The managers are just going to have to recognize these subtleties in standard cost systems and depend on upper management to be fair.
Human Resources Director - The key to employee productivity is employee satisfaction and a sense of accomplishment. A set of standards that can never be met denies managers of this vital motivator.
The current standards would be appropriate in a laboratory with a controlled environment but not in the factory with its many variables. If we are to recapture our old "team spirit," we must give the managers a goal that they can achieve through hard work.
Required - Discuss the behavioral issues involved in Merit Inc's standard cost dilemma. Evaluate each of the three responses (Pros and Cons) and recommend a course of action.