Question

Question 2: Budget (20 marks in total)

Kuipers Manufacturing is a medium sized company that manufactures and markets a range of products. The divisions of Kuipers Manufacturing include whitegoods, kitchenware and outdoor furniture. The senior management team oversees the budgeting process. This includes the managing director, the financial controller, the manufacturing director and the marketing director. Jack Kohler the managing direct of Kuipers Manufacturing, recognises the importance of the budgetary process for planning, control and motivation. He believes that a properly implemented process of participative budgeting and management by exception will motivate managers and their subordinates to improve productivity within their particular divisions. Based upon this philosophy, Kohler has implemented the following budgetary procedures:

• A target sales revenue and target profit figure are determined by the senior management team and given to each divisional manager for the following budget year. Profit targets are based on targeted overall increases in returns to shareholders and are assigned to divisions based on senior managements’ expectation of which divisions need to improve in the coming year. Target sales revenues are based on a percentage increase in the prior year's sales revenues for each division.
• Divisional managers develop their individual divisional budgets within the following constraints, as directed by the company financial controller:
  • The target sales revenue and profit targets can only differ by 10 per cent, and this deviation must be clearly justified by the divisional manager.
  • All fixed commitments should be included in the budget. Fixed expenditures include such items as long-term supplier contracts and salaries.
  • All capital expenditure projects that are undertaken in divisions at the direction of the senior management team should be included in the divisional budgets.
  • An estimate of head office charges is provided to divisions for incorporation in their budgets.
  • Division budgets need to specify all line items for expenditure.
• The final divisional budgets are approved by senior management, after scrutiny by the senior management team. Sometimes, as an incentive to motivate divisional managers, the estimated office charges are increased which has the effect of reducing budgeted divisional profits. Divisional managers are then asked to review their overall budgets to find areas of cost saving to meet t heir profit targets.
• The final budget is used as the basis of control for a management by exception form of reporting. Excessive expenditures by each division are highlighted monthly. Divisional managers are expected to account for all expenditures over budget. Financial responsibility is an important factor in the overall performance evaluation of all managers. Kohler believes that the polity of allowing the divisional managers to participate in the budget process and then holding them accountable for the final budget is essential especially in time of limited resources. He further believes that the division managers will be motivated to increase the efficiency and effectiveness of their divisions because they have provided input into the initial budgetary process and are required to justify any unfavourable performance.

Required:

Prepare a report to the senior management team that outlines the advantages and limitations of participative budgeting. In your report describe the deficiencies in Kuipers Manufacturing budgetary process. Recommend how each identified deficiency can be corrected. (500 words maximum)

Answer 1

Advantages of participative budgeting:

There are many advantages of participative budgeting. This includes transfer of information from subordinate to superior, increased job satisfaction, budgetary responsibility & goal congruence.

• Transfer of information is one of the biggest advantages because subordinates have the opportunity to reach out to their superiors directly & discuss their problems which can help in quick problem solving through exchange of information.
• Participative budgeting also has high performance rate when dealing with more difficult & more volatile tasks.
• In addition when people participate in setting up budgets they are recognized as members of the team because they are given the responsibility & motivation which can also increase the job satisfaction of the employees.
• Participative actions can also help in better & easy accomplishment of goals.

Limitations:

The major disadvantage of participative budgeting is that too much participation can result in negotiations which can drag & result in unnecessary delay. If the negotiation doesn’t reach an agreement, where the superior may have a final say in the matter it can be detrimental to the business because it can lower the morale of the manager & confidence in the work which he is trying to achieve. Next the attitude of the negotiators can affect the outcome.

Budgetary slack is another undesirable effect, happens because of overestimation of expense that can foster budgetary “gaming” through budgetary slack. Unless incentives to accurate projects are provided, padding the budget can be severe.

Deficiencies:

• The deficiency is that the “appropriation target” has been arbitrarily determined.
• Quantitative analysis seems to lack for performance evaluation & finance.
• Fiscal responsibility can be encouraged even more as a part of performance evaluation procedure.
• Department managers may be arbitrarily determining their departmental budgets.

Recommendations:

• If no one has been already employed, to would be advisable to come up with an appropriate methodology of appropriation target figure. Example of such methodologies would include input / output & incremental budgeting approaches.
• It would be good to develop a quantitative measure for fiscal responsibility & use it in evaluation of performances & reward good performers.
• It would be better to share financial savings with those who are fiscally responsible managers through a bonus program.
• It is advisable to use the minimum level approach which seems to be more suitable for department managers’ individual budgets.