HK Corporation is a manufacturing company specialized in producing a variety of plastic products. The budgeting process in the company has been a lot of difficulties, where the process starts from the managing director was constructing the budget through setting targets for total pound sales and net income at the beginning of the fiscal year, starting in late August. The budget then moves from the top to the Marketing Department, which establishes a sales budget, sales quotas for each of the company’s sale’s districts, and an estimation of the cost of marketing activities. The process moves down further to operations management, where operations manager determines the pound amounts devoted to manufacturing, which is then translated by the production department into units. Within the established cost constraints, the budget ends up with the production manager and manufacturing manager developing a manufacturing plan, at which point the budgeting plan usually stops due to constraints. As the targets set by the top management are not subject to change, the budget is then adjusted through cuts in costs related marketing and corporate office expenses.
Purpose of the Paper
This paper provides an analysis indicating the areas of failure in HK Corporation, the contribution of the budgeting process to such failures, possible revisions to the budgeting process, and the overall effect and benefits of implementing standard costing and variance system in budgeting.
The Failure of HK Corporation
The main problem of the budgeting process can be seen through its distinctive characteristic of being top-down budget. In that regard, although top-down budgeting has its own set of advantages, which can be seen through setting strategic goals and enforcing performance improvement, the failure to maintain balance within the established targets and the lack of coordination and feedback lead to negative effects.
In that regard, it can be stated that the top-down approach in constructing the budget in HK Corporation is an important factor in the failure on several levels. On the one hand, the targets set are unrealistically high, which can be confirmed through the implication of a repeated pattern in failure, where as stated in the case study “None of the areas has achieved its budget in recent years”. Thus, it can be stated that the top management fails to consider the failure in achieving the budget, and repeatedly impose high targets over the company’s different departments. In that regard, it can be assumed that such imposed budget reflects a certain strategy, e.g. increasing total sales and net profit, but nevertheless, the emphasis on such strategy is not supported by an increase in the resources that should be allocated to such strategy in general (Bhimani et al., 2008), and to the departments responsible for achieving the goals of such strategy in particular.
On the other hand, the system of control implemented in the budgeting process can be seen through cutting the actual costs, rather than revising the set targets. The employees are forced to cut the costs to match the set target, increasing the profit, which nevertheless lead to that the target is never met, neither in net income, nor in costs. In that regard, it can be seen that all of the latter contribute to the company’s failure, specifically in what concerns the employees, where the wrong approach motivate the employees in engaging in undesirable organizational behaviour. Such behaviour can be seen through the constant complaints concerning the management and the approach it implements, which can be seen from the dialogue of Adam and Ali, the purchasing manager and the manufacturing supervisor of HK Corporation respectively, and an increased tension between the employees from various departments, an aspect apparent through reaction on the employee delivering the monthly report.
Budgeting Process Revised
Describing the budgeting process as being top-down system, and at the same stating that such system contributes to HK Corporation failures, implies that the main revision that can suggested in this case is reversing such system into a bottom-up system. In that regard, rather than setting the targets and forcing other departments to adjust their costs and activities in accordance, the best solution would be through the other departments being involved in the targets set.
In such way, the influence on employees can be seen through improving the communication and the responsiveness of reporting the results, as opposed to the way the communication is usually conducted in top-down system. It was stated that “[p]eople at the front line of a top-down operation are hardly likely to report bad news if the inevitable result is a verbal beating-or to report good news, for that matter, if their reward is more ambitious targets” (Hope and Fraser, 2003). In the case of HK Corporation “verbal beating” can assumed to be taking place, according to the conversation of Adam and Ali, while rewards never happen, as top managers “don’t have time to review the good news”. Thus, the establishment of bottom-up budgeting process is likely to prevent such aspects.
Functional Areas’ Priorities
The cuts in the functional areas, when the target volume sales are not met, are dependable on several aspects. In that regard, the cuts should not be considered as a rule. Such aspects include the nature of the costs, i.e. variable or fixed. In that regard, fixed costs are the costs that remain constant, regardless of changes in the activity (Garrison et al., 2004). Thus, with marketing costs and parts of the administrative costs in HK Corporation being fixed, and others being variable, cutting costs which are fixed cannot affect the performance as they are not correlated with the activity. Accordingly, the costs during the span of one year, i.e. the working period of an established budget, can be relatively fixed. In other cases, when a slack present in the budgeted costs, there are costs in the functional areas that are less significant, and accordingly, can be delayed, and control is implemented over the costs, such costs can be cut. In that regard, it can be stated that none of the aforementioned exceptions is present in the case of HK Corporation, and thus, costs in the functional areas should not expect to be cut.
Motivation and Behaviour
The current implementation of a system of control in HK Corporation is concerned with a form of standard costs and variance system, in which standard costs are predetermined by the management. In that regard, the costs imposed by the management can be classified as ideal costs, i.e. costs representing perfect performance, where they ate the minimum costs that can established under the ideal operational conditions. Such classification can be seen through that the costs that are established by the top management are not attainable, they are not standards that are unchanged, and thus, it can be stated that the corporation set ideal targets as their standard costs.
Setting ideal standards as a regular benchmark to control the budgeting process can have a negative impact on the employees, and their motivation. Such effect can be seen through the motivation of Adam and Ali in the case, where the likely consequences are seen in a breakdown of corporate ethics (Hope and Fraser, 2003), such as reporting false statements, fraud, tension between employees and other adverse effects in motivation and behaviour.
Standard Costs and Variances
Despite the wrong approaches in implementing the system of standard costing and variance, such system has many advantages. The main purpose of standard costing and variance system can be seen through its usage a controlling technique, and in that regard its advantages can be summarized as follows:
- Measuring efficiency – the management can compare the standard costs and the actual costs, in order to evaluate the performance of various cost centres.
- Finding Variance – variance as the difference between the actual and standard cost, in that regard, the variance is an identification of the areas that need assessment and revision. In that regard, corrective measurements at earliest stages will help the management to prevent the deviation in performance if possible.
- Cost Control –implementing the system will help the costs to be monitored, and accordingly, if it is possible some costs can be reduced.
- Right decisions –In the case of HK Corporation, the system of standard costing and variance can be viewed as a feedback that will provide the management with the necessary information, when making vital decisions, such as implementing changes in the budget.
Recommendations for Improvement
The improvement to such system can be seen through the existing deficiencies in the way the management implements the system. First of such deficiencies are the standards set, where one way to improve the system can be seen through setting attainable standards, i.e. standards that are difficult, but not impossible, to achieve. Such standards can be determined through a system of feedback and communication between the company’s different departments. Setting attainable standards will make a space for any possible risks, such as the strike that delayed the delivery, mentioned in the case of HK Corporation. Additionally, the possibility of achieving such standards, if combined with reward with achieving them, will increase the motivation of the employees, which is an essential factor in the case of HK Corporation.
Another recommendation can be seen through the usage of the system in changing the structure of the budgeting process, from being imposed to being self-imposed, i.e. a budget that is prepared with the full cooperation and participation of managers at all levels (Garrison et al., 2004). With managers being responsible for reporting the costs and the variance, their participation in the budgeting process will help setting the standards, and making them attainable in that matter.
It can be concluded that the budgeting process as well as the system of control in HK Corporation is in need for several improvements. The system of standard costing and variance is a helpful tool that will help in constructing the budget, but nevertheless, should be implemented properly. Proper implementation implies setting attainable standards, which are achievable, which in turn will increase the motivation of the employees.
BHIMANI, A., HORNGREN, C. T., DATAR, S. & FOSTER, G. 2008. Management and cost accounting, Pearson Education EMA.
GARRISON, R., NOREEN, E. & BREWER, P. 2004. Managerial accounting, McGraw-Hill/Irwin.
HOPE, J. & FRASER, R. 2003. Who Needs Budgets. Harvard Business Review, 108 -127.