Management Accounting Case Assignment BY Allele Case 8-28. Evaluating a Company’s Budget Procedures. 1 . Identify the problems that exist in Ferguson & Sons Manufacturing Company’s budgetary control system and explain how the problems are likely to reduce the effectiveness of the system. The overall company’s strategy is not well defined by executives and communicated to the management. There is no goal other the cost reduction at total company level as well as at departmental level. Managers don’t see connection between expenses, revenues and overall company’s profitability.
As a result managers are frustrated because instead of help that budget is suppose to bring it creates problems. Managers don’t participate in budget’s development; it is purely a task of an accounting department which sets up performance goals for the company as a whole and all its divisions. Accounting department also controls the execution; other departments’ managers are completely removed from that process, they are only informed about their department’s performance at the monthly meeting.
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It turns out that department managers are accountable for the results that they never truly omitted to. This approach would lower company’s performance on the long run, when managers loose motivation they are not interested to deliver good results. Accounting departments has a very distant relationship with other operational departments; they concentrate on evaluating only financial goals, looking strictly at the numbers. They are only concerned with the cost reduction and continue to tighten the individual budgets once performance goal is met.
At the same time it looks like budget tightening strategy may become unreasonable because at some mint the only way the department can meet the budget is by sacrificing its quality for quantity. If quality becomes an issue, it may lose customers and potentials profits. The way the managers’ performance is being evaluated does not seem to be fair. Managers are not recognized well enough if they met the budget or even saved more than expected. They are being “rewarded” with the tighter budget every time they achieve the goal.
However if expenses end up to be higher than predicted, managers get a low rating during their monthly performance evaluation. The only motivation for managers to meet the budget is trying to avoid the low performance rating. With the current strategy managers are not rewarded for the good performance instead they are punished in both cases when they meet the budget and get the tighter goal or when they don’t deliver expected savings and given lower performance rating which also affect their income.
In this circumstance some managers may decide to leave the company and it may be hard to replace them, especially the most experienced ones. Company will incur the additional costs related to hiring the replacements. Operational processes are not well coordinated when special orders are given analysis being done to investigate the cause and no recommendations are made on how to avoid certain costs and improve the performance. The work between departments is not well coordinated either because all departments are over concerned with meeting their monthly budgets.
The maintenance department chooses not to help machine shop to fix their broken equipment Just to save time they need to meet their own department budget. However at the total company’s level expenses are higher because of idle time that loud be avoided if the maintenance department reacted to the problem on a timely manner. When departments can, they choose to first perform the Jobs that could be done with less time than budgeted; as a result the more important Jobs are being postponed. As a result the whole company’s performance may suffer.
Company would have to pay additional costs for idle time or for delaying Jobs that are more critical but require more time to complete then allowed by the budget. 2. Explain how Ferguson & Sons Manufacturing Company’s budgetary control system could be revised to improve its effectiveness. To be more efficient the company’s budget has to be done for the whole company. Departmental budgets should not be separately developed and evaluated since they are all part of the same company. In addition to setting cost reducing goals, it also has to set up revenue and profitability targets.
In addition to financial, it should have non financial measurements against which performance should be evaluated. The overall company’s strategy has to be reflected in the budget goals. Budgeting has to become a common effort for all level of managers when every manager participates n the goal setting discussions, agrees on the goal and feels accountability for the result. While developing budget, a set of clear and specific expectations has to be prepared which will help managers to compare actual and budgeted results.
Accounting department role has to change, instead of setting goals and controlling the performance it has to provide support to managers to help them to set up their own goals and provide with data supported by analysis to help managers to understand where the potential problems can be and make a decision on how to improve the performance. Variance analysis has to be done on a regular basis, all variances to the plan have to be investigated and explained, and then appropriate action should be taken to avoid the potential variance in the future.
Variance investigation should be a common effort for managers and accountants because while accountants are responsible for the financial part, managers provide expertise into other operational processes that they are responsible for in their departments. All the internal processes and expenses have to be analyses, especially ones that affect two or more departments. This would help to avoid some costs. To achieve company’s efficiency, all its internal Once budget is set it has to be reviewed and adjusted during every budgeting cycle.
The tightening of the budget would only make sense if it does not sacrifice quality and does not lower motivation. Company’s goals have to be realistic and could be revised if internal or external conditions change. Executives should also revise their performance recognition system and to tie individual managers clear goals to the results. Once manager understands the goals and feels his accountability he would be better motivated to meet these goals. Company should develop effective rewards and recognitions system other then “budget tightening” to increase managers’ involvement in company’s performance and to retain its best employees.
Case 108-5. Ethics and the Manager; Rigging Standards. 1 . How did Preston Lansing probably “rig” the standard costs – are the standards set too high or too low? Explain. Since Lansing rigged the standards so that they were always large favorable variances it means that he was setting standard costs too high because positive variance appears when goods produced at the lower costs then standards. That is he way to artificially overestimate Costs of Goods Sold and underestimate Operating Income up until the positive variance is recognized.
The way the costs are manipulated is when the positive variances are gradually recognized throughout a year showing increasing performance in second and third quarter and demonstrating the highest performance in the forth quarter. 2. Should Preston Lansing be permitted to continue his practice of managing reported earnings? This is an example of earnings manipulation and it should not be permitted. First of all Preston is being rewarded based on last quarter/year end results. The bonus would not be as high if the earnings were not manipulated.
This creates an ethical issue for the company. Manipulation should not be rewarded. Income Statement does not represent a true picture of company’s performance which may hide the existing problems. This is not acceptable from the external reporting prospective, when external users of the information are being misguided on company’s true performance. 3. What should Stacy Cummins do in this situation? Stacy was concerned about her findings and notified the president of the situation, but did not receive his support.
She could go further and bring it to the attention of the Board of Directors, particularly the audit committee, and outline problems that it may create for the company. It may not have desirable results since Board of Directors may already be aware about the issue but does not want to change anything in the current situation. If Stack’s actions have no results and she feels insecure in the current situation she may choose to leave the company to avoid potential problems if any controversy arises as a result of company’s unacceptable accosting practices and she may be liable for the professional misconduct.