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Tom Emory and Jim Morris strolled back to their plant from the administrative offices of Ferguson & Son Manufacturing Company. Tom is manager of the machine shop in the company’s factory; Jim is manager of the equipment maintenance department.The men had just attended the monthly performance evaluation meeting for plant department heads. These meetings had been held on the third Tuesday of each month since Robert Ferguson, Jr., the president’s son, had become plant manager a year earlier.As they were walking, Tom Emory spoke: “Boy, I hate those meetings! I never know whether my department’s accounting reports will show good or bad performance. I’m beginning to expect the worst. If the accountants say I saved the company a dollar, I’m called ‘Sir,’ but if I spend even a little too much—boy, do I get in trouble. I don’t know if I can hold on until I retire.”Tom had just been given the worst evaluation he had ever received in his long career with Ferguson & Son. He was the most respected of the experienced machinists in the company. He had been with the company for many years and was promoted to supervisor of the machine shop when the company expanded and moved to its present location. The president (Robert Ferguson, Sr.) had often stated that the company’s success was due to the high-quality work of machinists like Tom. As supervisor, Tom stressed the importance of craftsmanship and told his workers that he wanted no sloppy work coming from his department.When Robert Ferguson, Jr., became the plant manager, he directed that monthly performance comparisons be made between actual and budgeted costs for each department. The departmental budgets were intended to encourage the supervisors to reduce inefficiencies and to seek cost reduction opportunities. The company controller was instructed to have his staff “tighten” the budget slightly whenever a department attained its budget in a given month; this was done to reinforce the plant manager’s desire to reduce costs. The young plant manager often stressed the importance of continued progress toward attaining the budget; he also made it known that he kept a file of these performance reports for future reference when he succeeded his father.Tom Emory’s conversation with Jim Morris continued as follows:Emory: I really don’t understand. We’ve worked so hard to meet the budget, and the minute we do so they tighten it on us. We can’t work any faster and still maintain quality. I think my men are ready to quit trying. Besides, those reports don’t tell the whole story. We always seem to be interrupting the big jobs for all those small rush orders. All that setup and machine adjustment time is killing us. And quite frankly, Jim, you were no help. When our hydraulic press broke down last month, your people were nowhere to be found. We had to take it apart ourselves and got stuck with all that idle time.Morris: I’m sorry about that, Tom, but you know my department has had trouble making budget, too. We were running well behind at the time of that problem, and if we had spent a day on that old machine, we would never have made it up. Instead, we made the scheduled inspections of the forklift trucks because we knew we could do those in less than the budgeted time.Emory: Well, Jim, at least you have some options. I’m locked into what the scheduling department assigns to me and you know they’re being harassed by sales for those special orders. Incidentally, why didn’t your report show all the supplies you guys wasted last month when you were working in Bill’s department?Morris: We’re not out of the woods on that deal yet. We charged the maximum we could to other work and haven’t even reported some of it yet.Emory: Well, I’m glad you have a way of getting out of the pressure. The accountants seem to know everything that’s happening in my department, sometimes even before I do. I thought all that budget and accounting stuff was supposed to help, but it just gets me into trouble. It’s all a big pain. I’m trying to put out quality work; they’re trying to save pennies.
Review the case. Respond to the following:
- Identify the problems that appear to exist in Ferguson & Son Manufacturing Company’s budgetary control system and explain how the problems are likely to reduce the effectiveness of the system. (approximately 1 page)
- Explain how Ferguson & Son Manufacturing Company’s budgetary control system could be revised to improve its effectiveness. (approximately 1–2 pages)
- Explain how the use of an activity-based costing system could change the results of the budget, if utilized. (approximately 1 page)
- As stated in the case, many employees have “quit trying” and have altered behavior on the job. Provide specific ways for how you would use a budget to change employee behavior and align goals in the organization. Explain how goal alignment can improve profitability and overall return to the shareholders of the company. (approximately 1 page)
- Synthesize data to explain the concept of ROI and describe how the use of an activity-based costing system can improve the company’s ROI and the potential impact on free cash flow. (approximately 1 page)
Write a 5–6-page report in Word format.
Apply APA standards to citation of sources. Use the following file naming convention: LastnameFirstInitial_M5_A2 ..
| Assignment 2 Grading Criteria | Maximum Points |
| Identified the problems that appear to exist in the company’s budgetary control system and explained how the problems are likely to reduce the effectiveness of the system. | |
| Explained how the company’s budgetary control system could be revised to improve its effectiveness. | |
| Explained how the use of an activity-based costing system could change the results of the budget if utilized. | |
| Identified ways of how one can use a budget to change employee behavior and align goals in the organization and explained how goal alignment can improve profitability and overall return to shareholders of the company. | |
| Synthesized data to explain the concept of ROI, how the use of an activity-based costing system can improve the company’s ROI, and the potential impact on free cash flow. | |
| Wrote in a clear, concise, and organized manner; demonstrated ethical scholarship in accurate representation and attribution of sources; and displayed accurate spelling, grammar, and punctuation. | |
| Total: | 300 |
When analyzing overhead costs, it is essential to distinguish between variable and fixed:
· Total variable overhead costs vary in proportion to total changes in activity.
· Total fixed costs do not change within the relevant range.
This distinction is important when constructing flexible budgets and when computing overhead variances.
It is also important to understand the relevant range. Imagine a sports stadium that has a seating capacity of 55,000 fans. If the team playing in the facility is not winning games, ticket sales will be low. Therefore, it is likely that selling the capacity of 55,000 seats will be difficult. When a game is played, certain costs will be incurred regardless of the number of fans in the facility. These costs are known as fixed overhead costs and are incurred for aspects such as general lighting, property taxes on the building, insurance, and heating. In many cases, the stadium management would be willing to do whatever possible to fill up the stadium and get 55,000 fans into the seats, even if it means giving away free or very low cost tickets. This is because the relative cost of letting one more fan into the arena is low, so any revenue generated from the low cost ticket will help cover the fixed utility costs. At the same time, once the fans are in the arena, they often spend money on food and other souvenirs within the facility. Such spending generates substantial revenue that covers the fixed overhead costs. This revenue would not have been generated if the seats had been empty.
On the other hand, if the team is playing really well, there will be a strong demand for all 55,000 seats. In this case, tickets will not be given away, and in fact, fans would be willing to pay a premium cost to get in. Suppose the team plays well over a number of seasons and the demand for seats is consistently more than the capacity. Stadium management would need to make significant renovations of the arena to accommodate these fans. This would increase the fixed costs. In this scenario, the relevant range is the capacity of the facility. Fixed costs would not change if the number of fans seated in the stadium were between 0 and 55,000. However, above 55,000 fans, the relevant range is exceeded and the capacity would need to be increased, which in turn would increase the fixed cost. This is the only way in which the fixed cost can increase.
When analyzing overhead costs, it is essential to distinguish between variable and fixed:
· Total variable overhead costs vary in proportion to total changes in activity.
· Total fixed costs do not change within the relevant range.
This distinction is important when constructing flexible budgets and when computing overhead variances.
It is also important to understand the relevant range. Imagine a sports stadium that has a seating capacity of 55,000 fans. If the team playing in the facility is not winning games, ticket sales will be low. Therefore, it is likely that selling the capacity of 55,000 seats will be difficult. When a game is played, certain costs will be incurred regardless of the number of fans in the facility. These costs are known as fixed overhead costs and are incurred for aspects such as general lighting, property taxes on the building, insurance, and heating. In many cases, the stadium management would be willing to do whatever possible to fill up the stadium and get 55,000 fans into the seats, even if it means giving away free or very low cost tickets. This is because the relative cost of letting one more fan into the arena is low, so any revenue generated from the low cost ticket will help cover the fixed utility costs. At the same time, once the fans are in the arena, they often spend money on food and other souvenirs within the facility. Such spending generates substantial revenue that covers the fixed overhead costs. This revenue would not have been generated if the seats had been empty.
On the other hand, if the team is playing really well, there will be a strong demand for all 55,000 seats. In this case, tickets will not be given away, and in fact, fans would be willing to pay a premium cost to get in. Suppose the team plays well over a number of seasons and the demand for seats is consistently more than the capacity. Stadium management would need to make significant renovations of the arena to accommodate these fans. This would increase the fixed costs. In this scenario, the relevant range is the capacity of the facility. Fixed costs would not change if the number of fans seated in the stadium were between 0 and 55,000. However, above 55,000 fans, the relevant range is exceeded and the capacity would need to be increased, which in turn would increase the fixed cost. This is the only way in which the fixed cost can increase.
The complete set of budgets that covers all aspects of the operations of an organization is referred to as the master budget. Preparing a master budget can be difficult, as there are so many variables at play. The first step is developing a sales forecast. Once a company has a sales estimate for the year, operational budgets can be prepared based on the estimated production needs. After this, the individual budgets can be prepared for each department.
The first budget prepared is the production budget, which shows the number of goods or services that will need to be produced during the period. Next, thedirect material budget is created to show the number of units and the total cost of all the necessary materials to be purchased during the period. Then, thedirect labor budget is prepared to show the total number of direct labor hours needed and the cost during the period. The manufacturing overhead budget is developed next to show the cost of all overhead expenses that will be incurred during the period. The selling, general, and administrative expense budget is then prepared, and this shows the total amount of selling, general, and administrative expenses for the period. Next, the cash receipts budget is prepared to show the entire expected cash inflows for the period. This is followed by the cash disbursement budget, which shows all expected cash payments for the year. Once this set of budgets is completed, budgeted financial statements are prepared. These statements provide a forecast of the overall financial performance of the organization, if everything goes as planned.
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A standard costing system is the traditionally used costing system. It has two main purposes: cost control and product costing. Standard costs are determined by accountants working together with other employees of the organization. Such costs are created for direct material, direct labor, and manufacturing overhead. A cost manager would use these standard cost figures as a benchmark with which to compare actual costs. This allows managers to determine if there are any substantial cost variances.
The variances that management will compute to monitor performance include the following:
· Direct material price is the difference between the actual and standard price
· Direct material quantity is the difference between the actual quantity and the standard quantity
· Direct labor rate is the difference between the actual and standard hour rate
· Direct labor efficiency is the difference between the actual hours and the standard hours
There is no set rule to indicate when a variance is considered too high. Managers must use their own judgment and business sense to make this determination.
Overhead is one of the most difficult costs to account for because it is a large pool of all the different indirect costs. Tracing the overhead costs to each individual product or service is laborious, which is why a flexible budget is created. In a flexible budget, overhead costs are specified for various activity levels. There are two types of flexible budgets that can be used. The first, thecolumnar flexible budget, is based on several different activity levels. The other type, the formula flexible budget, is used for a continuous range of activity.
Once the flexible budget is created, variances can also be examined to find out how well the company is performing.
These variances include the following:
· Variable overhead spending is the product of the difference between the actual and standard overhead rates and actual quantity [(Actual overhead rate – Standard overhead rate) × Actual quantity].
· Variable overhead efficiency is the difference between the actual and standard quantity (Budget allowance on actual quantity – Budget allowance on standard quantity).
· Fixed overhead budget is the difference between actual and fixed overhead (Actual overhead – Fixed overhead).
· Fixed overhead volume is the difference between budgeted fixed overhead and applied fixed overhead (Budgeted fixed overhead – Applied fixed overhead).
When analyzing variances it is important to understand whether the variance is favorable or unfavorable. A favorable variance indicates that the company has benefited from the variance, for example, when actual costs are less than budgeted. An example of an unfavorable variance would be that actual costs were greater than budgeted.
The analysis of variance can be a difficult task, but it is important to spend the time necessary to do this because variances tell a lot about the overall performance of a company. Knowing how well a company is performing is necessary for maintaining long-term success.
Budgets affect just about every department and every person within an organization. This tremendous impact causes people to act differently to make sure the budgets are met. One common way of doing this is to pad budgets. However, this makes the prepared budget less useful, as it is not an accurate representation of the company. A company can ensure the accuracy of budgets by involving employees throughout the organization in creating the budgets. This process, referred to as participative budgeting, makes employees feel more involved, and they are likely to be more willing to stick to and follow the budget.
Budgeting can be a very time-consuming task, but it is necessary if a company is to maintain business for the long term. Most companies have a budget director who is in charge of budgeting to keep everything organized. Organizations will also have a budget committee made up of senior executives who help advise the budget director. It helps to have people who are familiar with budgeting involved, as this makes the process run smoother.
Budgeting is extremely important, whether for personal or business reasons. Budgets are of many types and are the main tools used for planning, control, and decision making in almost every organization. These can also be used to force organizations to plan for future communication, coordination, resource allocation, profit control, and performance evaluation.
Many professional service firms rely heavily on the use of time budgets. For example, architect firms know on average how long it takes to work with commercial clients on the design of a building or with individuals for a house. Based on these estimates, management assigns clients to architects within the firm and estimates the fees that will be charged. If one architect has five clients assigned to him or her and each design is budgeted to be completed in ten hours, this means that fifty hours of work have been delegated for completion by that architect. Additional work will not be assigned to this architect until all other architects are equally assigned the same number of hours. Additionally, if it takes this architect ninety hours to complete the designs, as against the assigned fifty hours, this may be a sign there are issues with the productivity of this architect that need to be examined.
In the assignments you will get an opportunity to examine how budgets are used to analyze performance and set incentives for employees and management within an organization. You will also make recommendations for improving the effectiveness of such systems.
