Introduction
HK Corporation, manufacturing plastic products is confronted with the problem of unable to meet the budgeted sales and profitability. While the targeted sales in terms of monetary value and the expected net income for the ensuing budget period is set by the managing director of the company, the individual departments translate these estimates into quantitative budgets. This paper analyses the deficiency in the budgeting process and recommends standard costing as a supplement to the budgetary process. The paper also discusses the behavioral aspects of the budget process and advises the adoption of flexible budgets in the place of static budgets to improve the overall performance of the company.
Flaws in the Existing Budgeting Process
The existing budgeting process being followed by HK Corporation represents a top-down approach where the managing director specifies the monetary levels of sales and net income. These are the parameters on which the budget is to be prepared. The lower level of people have very little to contribute in the budgeting process and to set the overall goals of the organization. The contribution of the lower level executives is only the responsibility of doing the basic budget calculations consistent with the directives from the managing director. One of the major disadvantages of the top-down approach is that the lower level managers may view the budget as a dictatorial standard. (PrinciplesofAccounting, 2007) Such an environment can for sure result in resentment among the organizational members. The budget targets in this case may also give rise to ethical challenges, with the lower level managers having the feeling of being unable to attain the unrealistic targets. The shortcoming of a top-down and static budgeting process can be overcome to some extent by revising the budgetary process through including the lower level managers also in the process.
Revision in the Budgeting Process
The budgetary process in HK Corporation should be revised forming a budget committee which will enable the organization to prepare a comprehensive budget. The budget committee may consist of representatives from each department for conducting the budget process. The budget committee may be spearheaded by the managing director. The individuals constituting the budget committee members may be the production manager, sales manager and the purchase manager apart from the finance manager. These people will be able to bring valuable insight into the budgeting process instead of the top-down approach which is being presently followed. The budget committee members may also take part in the monitoring the performance of the departments against the budgets and recommend corrective actions whenever they find significant deviations from the budgets. The budget committee members can also introduce flexible budgets based on the actual performance to assess the performance of different departments.
Introduction of Flexible Budgeting
The question of whether the functional areas are expected to cut their costs can be answered by the adoption of a flexible budgeting system. As against the flexible budget, a static budget is based on the level of output planned at the start of the budget period. When variances are computed from a static budget at the end of the period no adjustment is made to the budgeted amounts even though the actual production may be different from the budgeted output. Therefore it becomes important that a flexible budget is developed using the budgeted costs and revenues as applied to the actual level of output achieved during the budget period. Therefore when sales volume falls below the budget the functional areas can revise their budget according to the revised sales volume and compare their actual performance against the revised budgets.
Behavioral Aspects of Budgeting
Presently the production manager and the purchase manager have a feeling that they do not get a proper feedback on their actual performance against the budgeted levels in time to take corrective actions wherever necessary. Another issue with the present budgeting is that their actual performance is compared against the static budgets which do not take into account the variations in the actual performance. The introduction of standard costing and variance analysis would improve the assessment of the performance of the individual departments to become more meaningful. Standard costing enables the executives to focus on inefficiencies in the process and thereby enable them to improve the productivity of the individual departments. The objective of instituting a standard costing system is to get an effective control over cost by recording the budget amounts through work-in process, finished goods and cost of goods sold accounts as well as the actual costs incurred (Davidson, 2008). The budget figures may be arrived at based upon the actual, budgeted or standard costs implying that these are not mutually exclusive (Newman & Oliverio, 1999). The difference between budget and actual costs provide the vital information for an effective cost control. The budgeting process comes handy in establishing various standards for adoption in the costing system. Planning variable overhead costs and fixed costs will enable the organization to make key decisions on the level of activity that can be undertaken in the ensuing period. By preparing various budgets such as sales, production, and overhead budgets it becomes easier to fix the standards for the overhead items against which the standards can be compared for ascertaining the variances and take corrective actions. Thus development of standards is a significant part of the budgeting process even before the organization plans the start of production. While a budget relates to an entire activity or operation, a standard pertains to the cost information on a per unit basis (Drury, 2006). This improves the analysis of performance to a great extent.
Implementation of Standard Costing
Standard costing is a costing method that traces direct costs to a cost object by multiplying the standard price or rate with the standard outputs allowed for actual outputs produced. The indirect costs are allocated based on the standard indirect rates multiplied by the standard inputs allowed for the actual production (Horngren et al., 2002). The main advantage of standard costing which fits very well with HK Corporation is that when standard costing is implemented the costs of every product or service planned to be produced can be computed at the start of the month (College Accounting Coach, 2006). Therefore the production manager will know in advance how he will be able to perform in the following month and this eliminates the anxiety of expecting the budget analysis that will be circulated towards the end of the following month. The standard costing system also enables the purchasing manager to arrange for the required materials in advance and removes the stress on his part to arrange for last minute purchases. The system also enables a simplified recording of the costing information. “No record need be kept of the actual cost of items used or the actual quantity of the cost-allocation base used on individual products or services worked on during the period.” (Horngren et al., 2002) This makes the costing system very simple. Standard costing thus provides the best basis for estimation of the future costs and contributes more to the budgeting function.
The products of HK Corporation are mostly standardized and some of them are made according to customer specifications. Therefore it becomes easier to establish a standard costing system for the company. Based on historical consumption figures and the labor hours for different products the company can establish a standard costing system that provides.
Conclusion
To sum up the present top-down approach to the budgeting process in HK Corporation needs a complete revamping. The organizational efficiency can be improved to a large extent and the employees will remain motivated by instituting a budget committee consisting of the executives form all the functional departments and the introduction of a standard costing system. The standard costing system provides a meaningful basis for the executives to monitor the progress of the actual performance and take corrective action where they find inefficiencies affecting the performance. As against the static budgeting, the introduction of flexible budgeting will also enhance the value of comparison of actual performance against the budgeted levels. The standard costing system offers an effective means of management by exception to focus on more significant variances and it also provides an effective basis for considering revision in prices and the effect of price fluctuations of material on total production costs. HK Corporation needs to take into account the various issues discussed in the paper to redesign its budgeting process to ensure an effective organizational performance.
Reference List
CollegeAccountingCoach, 2006. Standard Costing Defintion, Uses, Advantages (Part 1).
Davidson, L., 2008. The Difference Between Normal Costing and Standard Costing. Web.
Drury, C., 2006. Cost and Management Accounting – An Introduction. USA: Cengage Learning.
Horngren, C.T., Foster, G. & Datar, S.M., 2002. Cost Accounting: A Managerial Emphasis. New Delhi: Prentice Hall of India Private Limited.
Newman, B. & Oliverio, M., 1999. Standard Costing. Web.
PrinciplesofAccounting, 2007. Chapter21: Budgeting: Planning for Success. Web.