Ferguson & Son Manufacturing company is attempting to increase efficiency and reduce cost by introducing monthly performance reports for each department. Robert Ferguson Jr is trying to introduce this new type of accounting system and when you try something like this you will always run into some problems, but Robert is creating a culture of resentment. Robert Ferguson is using a static planning budget to analyze the performance of each department.
Garrison, Noreen & Brewer (2012) define a planning budget as a budget “prepared before the period begins and is valid for only the planned level of activity (p. 385)” Robert is using a budgeted level of activity and comparing it to the actual level of activity as the basis for the evaluations. The information that is received from an evaluation done in this manner is going to be misleading. The budgeted level of activity is not always going to be the same as the actual level of activity, so a true comparison is impossible.
For example my company manufactures safety belts for motor vehicles and the budget is based on an activity level of 5000 units for the period. The actual level of activity for the period is 4000 units and in result costs and revenue are lower than the budget amount. If our company compared the costs are going to be different simply because the activity level is different then the unchanged planned amount and the results will not provide conclusive data for performance and efficiency because there is no true controlled factor.
Garrison, Noreen & Brewer describe this as comparing apples to oranges. This type of system is going to provide incorrect data for performance, in result the company will not be able to understand their costs and true revenue potential. The planning budget system is going create discrepancies in the spending variance. According to Garrison, Noreen & Brewer (2012) the spending variance is “the difference between how much a cost should have been, given the actual level of activity, and the actual amount of the cost (p. 91)”
The spending variance can be evaluated as favorable or unfavorable, and this could effect how the product is priced or even purchasing new high tech equipment. You can not effectively utilize a spending variance in a planned budget system because you do not use the same activity level to compare cost. These are big decisions that can make a big impact on a companies revenue and if the system is not using the actual activity level and costs and comparing to the actual levels, the spending variance will be evaluated incorrectly.
The planning budget system is going to effect the morale of the supervisors and employees dramatically. Robert Ferguson Jr is evaluating the performance of the supervisors and departments monthly based on amounts and activities that they have budgeted. This budget could be completely unrealistic and this will cause the entire staff to feel hopeless and bitter. Once people begin to feel hopeless, their work performance will fall, production and efficiency will naturally follow. Their work performance will take into consideration the quantity of their work, but more importantly the quality of their work.
If your employees feel they have to cut corners to meet budget to keep their jobs, they will do so and the company could begin to alienate their customers. To continue the seat belt example, if my company had to produce 5000 units and this was impossible unless the workers cut a few corners; now the company has faulty seat belts going to car companies. This could cause a large recall on the cars that our clients produce and those clients are going to find a new company to work with for these products.
In this example, my company just lost a tremendous amount of money due to an accounting system that demands so much of their workers that the quality of their work has to be sacrificed. This is all due to notion of increasing efficiency without comparing the activity levels and costs in the same manner. Ferguson & Son Manufacturing should adapt a flexible budget system to improve efficiency.
Garrison, Noreen & Brewer (2012) define a flexible budget as “an estimate of what revenues and costs should have been, given the actual level of activity for the period(p. 385). Garrison, Noreen & Brewer (2012) go on to say that “when a flexible budget is used in performance evaluation, actual costs are compared to what the costs should have been for the actual level of activity during the period rather than to the static planning budget (p. 385). ” The activity level will change each period, through out the period as the business activity increases and decreases. Emory says, “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 set up and machine adjustment time is killing us. This is an example of the type of activity that is going to happen and needs to be taken into consideration when one is evaluating efficiency. The flexible budget will take into consideration this activity and compare the costs to the same level of activity. The current planned budget does not take this into consideration and these are issues that the supervisor has no power over. With the knowledge from the flexible budget, Robert Ferguson Jr may decide that if they purchase a new machine they could complete these rush orders, not have any idle time and in result increase efficiency.
In the flexible budget system, Robert will be able to effectively evaluate the spending variance and assess the performance of his workers. The flexible budget is going to make the supervisors and other workers feel they are being measured fairly and can have a positive sense of accountability. During each accounting meeting supervisors like Tom and Jim will be able to walk in confidently, look at the activity of their departments, what their costs should have been based on the activity, what it was actually and see where they can improve.
Tom and Jim have been working at Ferguson & Son for a very long time and understand what they and their teams can accomplish. They have been praised for the quality of their work by Robert Ferguson Sr and their expertise can be the most efficient tool Robert Ferguson Jr has in the factory. Flexible budget system will create realistic goals for the workers and in turn relieve the negative stress being placed on them. The quality of work will not be sacrificed to cut costs, Tom and Jim will incorporate new work practices to increase efficiency. Activity-based costing could be a great tool for Ferguson & Son Manufacturing f used properly.
Activity-based costing is defined by Garrison, Noreen & Brewer (2012) as “a costing method that is designed to provide managers with cost information for strategic and other decisions that potentially affect capacity and therefore “fixed” as well as variable costs. Activity-based costing is ordinarily used as a supplement to, rather than as a replacement for, a company’s usual costing system (p. 273). ” Activity-based costing takes into consideration all different types of costs as they relate to the activities, so managers can make more effective decisions.
Garrison, Noreen & Brewer (2012) state the implementation process for activity-based costing breaks down into five steps and these steps are define activities, activity cost pools, and activity measures; assign overhead costs to activity cost pools; calculate activity rates; assign overhead costs to cost objects using the activity rates and activity measures, and finally prepare management reports. The first step is going to require the company to interview supervisors of each department to understand the activities, activity cost pools and activity measures.
This will involve the supervisors and give the company a better grasp of the activity, but make the supervisors feel they are a part of the process and team. This will in turn improve their confidence and overall morale. Once they have interviewed the supervisors and understand the activities, they will be able to assign overhead costs to activity pools such as the rent for the factory to production or the salaries of the marketing managers to the marketing department. The next steps will have them assign rates and costs to certain objects.
Activity-based costing will allow Ferguson & Son Manufacturing to become more efficient by giving them the ability to see what areas need the most improvement. Activity-based costing breaks down the costs for each department and activity in a way that Robert Ferguson Jr can assess the report and use the theory of constraint to locate the department that needs to improve and effectively take the steps to improve that department. As the system is continued to be used the company will see their efficiency rise and in results so will the company profits.
Individuals are always working towards a purpose or some type of goal and that is what a budget can provide. I would utilize a budget to create a sense of urgency, competition and direction in the work place. I would utilize a responsibility accounting system. Garrison, Noreen & Brewer (2012) define responsibility accounting as “a system of accountability in which managers are held responsible for those items of revenue and cost—and only those items—over which they can exert significant control.
The managers are held responsible for differences between budgeted and actual results (p. 337). ” This type system will allow the managers to be held responsible for the items they can directly control, by involving them in the process and not automatically penalizing them for not meeting their goals immediately. Everyone wants to feel there are part of a team and involved in the process of creating their own goals. I would implement a self-imposed budget system to help create a sense of control for all workers and managers of the organization.
Garrison, Noreen & Brewer (2012) define a self-imposed budget as “a method of preparing budgets in which managers prepare their own budgets. These budgets are then reviewed by higher-level managers, and any issues are resolved by mutual agreement (p. 338)”. I would create a budget committee that includes the managers to provide everyone in the organization this sense of unity. Once a budget is created and the workers have a sense of control and unity I would create an incentive program to encourage workers to accomplish and exceed their goals.
I would implement a bonus incentive plan for my workers. This system would utilize the budget created by the organization and further inspire the workers to excel. People are motivated by many different things and most of them involve factors that are not directly related to the work place. People work to provide financial security for their family, prestige outside of work and pride for the work they do. A bonus program will give each individual the opportunity to accomplish any or all of these personal goals and contribute to the success of the organization.
If each person in the organization is striving to surpass their goals, the organization will do the same and the results will be evident to the shareholders. Garrison, Noreen & Brewer (2012) define return on investment as the “net operating income divided by average operating assets. It also equals margin multiplied by turnover (p. 475). ” The return on investment is the profit of the organization. Activity-based costing allows larger companies to understand what their costs are, where they are coming from and how to effectively reduce them to create the largest return possible.
Activity-based costing systems do have start up costs associated with them. The organization must train personal to understand the process and systems in order to properly accomplish these activities. The organization must interview staff to research their departments properly to get the accurate information vital to the success of activity-based costing. These costs are the reason many smaller organizations can not apply this system.
Activity-based costing provides the organization with the ability to dissect their departments activities and costs. This will allow the organization to see what areas need improvement, what costs can be avoided, in result increase profits and free cash flow for possible expansion or upgrades. If Robert Ferguson Jr can see what departments are costing the company excessive amounts of money, he can lower or eliminate those costs. Once Robert reduces the cost of production, the revenue will rise and the return on investment will grow.