Introduction
A budget is defined as an action plan that is presented in quantifiable terms (Ahmed, 1992). This is commonly done by the cost accountant. While the financial accountant deals with the reporting of the financial position and performance of the company, the cost accountant’s role is to present, manage and monitor costs through balancing estimated costs with the actual costs being incurred (Barry, 2003). This evaluation is done to determine the variance and come up with means and ways of ensuring that the costs are strictly kept under budget.
The importance of budgeting therefore cannot be overemphasized. Budgetary control is a term that is used to refer to the management technique employed to ensure efficient and effective control of the firm’s operations. The difference between budgets and budgetary control comes in that while budget means the standard measure with which actual results are compared with the planned, budgetary control means the whole set of advanced managerial planning that is aimed at controlling the business as a whole (Alnoor, 2003).
The benefits of budgets and budgetary control are far-reaching. First, budgets help the organization in planning. Budgets present clear guidelines with which planning of both the financial and non-financial resources are made to achieve the operational targets and hence the organizational goals (James, 2001). Communication and coordination between the management and the employees are also enhanced through budgeting. Budgets are also used as tools of monitoring, evaluation, control, and reformulating the business policies to ensure the attainment of the set targets.
The success of a company largely depends on its ability to achieve the planned actions as well as monitor the set policies (James, 2001). This together with the budgetary control helps the firm achieve its goals through close monitoring of the set procedures. In doing this, the firm’s past performance is analyzed plans are set and effective attainment is guaranteed to a high degree of assurance.
The Problems that Exist in Ferguson & Son Manufacturing Company
Fergusson & Son Company has a major emphasis on costs. It seems that the management’s great concerns are controlling costs through cost minimization. An in-depth look at budgetary control reveals that it not only concerns itself with the financial aspect of planning but also the non-financial aspect (James, 2001). Budgetary therefore does not exclusively mean controlling budgets through minimizing the costs. It includes such aspects as cost allocation, monitoring, and re-allocation whenever the actual versus the budgeted variance is greater. This usually entails either increasing the cost allocation in some operational areas or reducing it in others.
It has been claimed that whenever the budgets are achieved the plant manager tightens the budget further. Although this is aimed at achieving efficient operations, it comes at the expense of production. With the possible ever-increasing market inflation, cutting budgets means that production levels will have to drop. This, with other market economic forces, will compel the equilibrium to drop, and hence the desired level of production will drop.
A mere achievement of the budget does not mean that the firm has managed to control its operations. This is because an analysis of costs reveals that the relationship between a variable and fixed costs plays an important role in ensuring that the production levels are maintained at the best levels possible. Fixed costs are the costs that remain constant with a change in the activity level (Horngren, Foster, & Datar, 1999). Variable costs on the other hand refer to the costs that increase with an increase in activity level and reduce with a fall in the activity level.
The mistake the company is making when cutting the budget is reducing the costs most of which is the variable cost. A reduction in variable cost has a direct impact on the level of production since it is directly proportional to the activity level. While the fixed costs are hardly altered in any budget, the variable costs suffer the most more so when the main target of cost reduction is to increase the efficiency of the firm (Barry, 2003). The Company’s management should therefore know that a reduction of the costs affects the production levels and although efficiency is achieved, other factors are negatively affected and this may push the equilibrium down. If the equilibrium is pushed down, the total productions will consequently fall and an analysis of the contribution margin reveals that the firm’s unit cost has gone up.
It has also been established that there is a conflict between the machinery shop manager the equipment maintenance manager and the Accountants. Accountants’ major concern is the optimal allocation of costs to the various cost centers in an organization (Pauline & Sidney, 2007). If this is taken as the primary concern in any organization, the company may experience difficulties when planning and implementing expansion plans. This is because of the limiting factor or the principal budget factor.
The limiting factor is referred to as that factor in an organization that limits the activities of an organization. In most organizations, the limiting factor is financial resources. This is because financial resources are usually scarce and organizations usually try to allocate the scarce resources among competing needs. Fergusson & Son manufacturing company has paid extensive attention to financial resources. This has made the management concentrate so much on cutting costs at the expense of other activities such as quality and production volumes. This may harm the production and subsequent profitability of the company.
How the budgetary Control System Could be Revised
Budgetary control is a vital aspect of the management of any organization. Effective use of any organization’s budgetary control usually results in harmonized operations that ensure the achievement of optimal results in the most desirable manner (James, 2001). As such, Fergusson & Son Company should employ some effective budgetary control measures.
There are different types of budgets. They include static, flexible, and master budgets. The company has a practice of strict observance of the static budget. The disadvantage of this is that the static budget fails to accommodate the unavoidable contingencies that may require extra amounts of money or reduce the amount of money used against the budgetary allocation. The company should therefore adopt the use of the flexible budget when coming up with budgetary decisions. This would help in ensuring more realistic budgetary expenditures and the incorporation of contingencies in the budget.
The company should also put consideration on the production budget versus the variable costs. This would help in managing the production levels. An understanding of the types of costs reveals that the fixed costs remain unchanged with a change in the level of activity. This is unlike the variable costs which change with a change in the activity level. The company ought to incorporate the use of a budgetary system that recognizes that a reduction in the costs results in a subsequent reduction in the level of production since it only affects the variable costs. This budgetary control system would therefore help in obtaining optimal costs versus production rather than minimized costs.
The company could also form a budget committee. This is a team of individuals usually headed by the general manager and is charged with the responsibility of formulating the general procedures of budget preparation (James, 2001). The importance of a budget committee is that it objectively evaluates the various budgetary allocations and constantly monitors and appraises the various expenditures against the allocations. The budget committee would assist the departmental managers to prepare their budget estimates and coordinate a proper implementation of these budgets.
The company could also have a budget manual. This is usually referred to as the rule book (Horngren, Foster, & Datar, 1999). The budget manual helps in laying down the rules that govern the setting of budgets and spells out the various responsibilities by various individuals as well as setting the budget timetable (Barry, 2003). The importance of a budget manual comes in where the company sets the parameters that ought to be adhered to when coming up with a budget and budget estimate.
The appraisal methods that are employed by the management should put into consideration other factors more so the remote factors that govern the organization. These factors may be responsible for most of the variances between the actual and the budget expenditures. The company should from time to time revise its budget estimates to incorporate the planned growth as well as the unplanned contingencies. This is a desirable practice since most organizations operate in an environment that is highly volatile and keep on changing.
Adoption of standard costing method as a budgetary method is also a very important aspect of effective budgetary controls. Standard costing is where an activity’s standard cost is established and then the cost is multiplied by the actual activity (Alan, 1963). If the company’s costs increase with a subsequent increase in the production levels, there is no need to stress cutting down the budget. By using standard cost the company would ensure an objective and realistic method of budget management and budgetary control.
Conclusion
The budgetary control system is an important management technique. This is because it is used to effectively control business activities. Budgetary allocations should follow realistic approaches that put into consideration the various limiting factors in the organization. Most organizations make the mistake of looking at financial resources as the sole limiting factor. This usually results in adverse effects on the organization’s operations. As such, organizations should consider the inclusion of various costing methods such as the use of standard costing and so on. This would help to monitor the production levels as they relate to the budgetary allocations.
Fergusson & Son Company should therefore employ such budgetary methods to ensure that the various departments do not have to strictly manage their budget allocations and expenses if their production is directly related to the various expenses. The company would therefore focus on growth rather than cutting budgets. The various departmental managers could then be encouraged to increase their production levels which would match and justify increased expenditures.
These factors, if put into consideration would ensure that the company’s management changes its view of expenses to focus on production levels. The management would also have an advanced budget system that would streamline the budget system and have an effective cost versus production mode of budget appraisal.
References
Ahmed, R.-B. (1992). The new Foundations of Management Accounting. New York: Quorum Books.
Alan, H. W. (1963). Public Finance and Budgetary Policy. New York: Praeger Publishers.
Alnoor, B. (2003). Management Accounting in the Digital Economy. Oxford: Oxford University Press.
Barry, E. L. (2003). Management Accounting Demystified. New York: McGraw Hill.
Horngren, C., Foster, G., & Datar, S. (1999). Cost Accounting – A Managerial Emphasis ( 10th ed.). New York: Prentice Hall.
James, P. L. (2001). Project Planning, Scheduling, and Control: A Hands-On Guide to Bringing Projects in on Time and on Budget. New York: McGraw-Hill.
Pauline, W., & Sidney, J. G. (2007). International Financial Analysis and Comparative Corporative Performance. Journal of International Financial Management and Accounting , 111-30.