Accounting Principles and Applications: Analysis

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The use of budgeting within the organization can make the business to be successive due to the many benefits associated with budgeting. However, there are some problems that may arise when budgets are used as part of ‘performance contracts’ between an organization and its managers (Druly, 2008).

The managers tend to avoid many risks and this is revealed when they set high production costs so that the target returns are low. For example, the Bestmould Division charges RM$1,000 per kilogram of molded products to profit centers, in order to cover RM$100,000,000 for its fixed costs. For the output given, it receives RM $ 200,000,000 which is higher than the fixed costs. While other companies have a quality check level of only 10% of throughput on a daily basis, the management of MRG, only sets it at 25% to avoid risks of poor quality.

Prices of inputs do change from time to time due to variations in demand and this may put the managers into very difficult situations especially if they do not have sufficient funds for emergencies (Robert, 2001). At MRG, the forecast is not accurate since 40% of the annual requirement at the Bestmould Division can be obtained from another division.

Only the lowest targets are met. When the managers know that the budgets are to be used for performance evaluation, the targets may be set at very low levels so that they can be easily met. Therefore the management may not be able to set the budgets realistically as they may set it lower than the forecasts. The 25% quality checks ensure that not all products are of high quality, and hence the management may only want to meet the 25% level of the throughput.

Meeting the target, but not beating it. It is possible for the employees or management to only aim attain the set targets after which they will no longer work extra or further than what is required. As long as they are able to meet the lower targets, they can then remain idle unlike those who have no set targets (Jerold, 2005). This makes the managers to set very low level of targets that they can easily attain and relax afterwards e.g. the output of 200,000 kilograms for MRG is too low compared to other companies.

If there is a bonus set for both managers and employees who meet the specific targets, it motivates them to do anything so that they can get the bonus. For example, the 5% set bonus that is payable as long as the budgeted output of 200,000 kilograms has been achieved, compromises the quality of output. An employee may only focus on attaining the target (Evans, 1997).

There is competition against other divisions, business units and departments. Divisional managers may have an intention of trying to compete with one another when they decide to have selfish interests or try to embrace the top management in terms of performance (Smith, 2007). This means that they may want to charge a higher transfer price to other departments or divisions so that to increase the costs for the other divisions which will eventually lead to very low levels of profit in those departments. The standard cost for the molded products includes 15% loss which is too high, with the aim of making huge profits in case the loss is not incurred.

The resources may be excessively allocated by the mangers especially if they have some over expectation of variance in the resources required. Financial resources are the most likely wasted resources in many organizations (Reference for business, 2011). Time resources may also be overused by allowing of too much or unnecessary idle time. For example, the 5% idle time allowed on the machine hours may be unrealistic. A new machine could be outsourced from a specialist company.

Ensuring that what is in the budget is spent. If the budget is not accurately set, there are chances of having excess funds which the management may want to spend or allocate wastefully with the intention of sticking to the budgets (Leslie, 1992). Even the 5% idle time allocated for the molded product may make them be idle for more hours just because it is shown in the budget.

The following recommendations may help to avoid these problems:

The costs should be regulated by ensuring that they are not too high or exaggerated in any way. The budgets should be benchmarked to the other companies. This eliminates the problem of avoidance of risks.
To avoid inaccurate forecasts, the budgeting committee should evaluate all budgets before they are implemented. Research has to be done earlier in time and allow preparation of flexible budgets (Global consulting, 2009).
To avoid meeting lowest targets, the bonus scheme should be based on extra output produced beyond the set target.
Introduce rewards for those who exceed the targets to ensure that the targets are beaten (Kaplan, 2003).
The transfer price should be at cost only and avoid rewarding each department separately in order to reduce the interdepartmental competition (Horace, 2000).
To avoid wastage of resources, there should be some limits as to how much idle time should be allowed to machine hours or outsource a new machine.
To avoid spending everything in the budget, the budgets should be flexible to allow for adjustments.
The output should be evaluated on the basis of quantity and quality to avoid instances of employees who may do anything to get the bonus.

References

Druly, J. (2008). Management and cost accounting. London: Thomson Learning.

Evans, P. (1997). Strategy and the new economics of information. New York, NY: Harvard Business Review.

Global consulting. (2009). Web.

Horace, R. (2000). Accounting principles and applications. New York: McGraw-Hill.

Jerold, L. (2005). Accounting for decision making and control, Chicago: Irwin.

Kaplan, R. (2003). Translating strategy into action. Boston: Harvard Business Review.

Leslie, J. (1992). The portable MBA in finance and accounting. New York: Wiley. Reference for business. (2011). Web.

Robert, N. (2001). Management control in non-profit organizations. Homewood, IL: McGraw/Irwin.

Smith, J. (2007). Handbook of management accounting. Amsterdam, Boston: Cima Publishing.

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Accounting Principles and Applications: Analysis

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