Preparation of Budget for Production Unit

Case Study-3
Sri Harshaw
Sri Kiran
Giri
Rohit Reddy

Abstract
This summary briefs about the steps that are followed in preparation of the budget for Production unit in Parkway Industries for the upcoming year. New budget process is advised to follow for making the estimate of the budget for the upcoming year to overcome the shortcomings of the previous budget estimate. Kairen Bailey is promoted to department manager of production unit in Parkway Industries.
She is happy about the job but not happy with the evaluation measures followed to make the annual budget estimate. Bailey want to make certain changes how the evaluation process to be carried out.
Budgetary slack was discussed as means to maintain some consistency in budgeting matters.
Budgetary slack refers to the deliberate adjustment of additional cash outlays in expectation of future cash flow. Budgetary slack functions by undervaluing the total income or revenue that the business expects to receive in a specific period of time. These practices can also include overstating the expenses the company expects to pay out over the same time frame. The issues surrounding budgetary slack can be both functional and ethical, as these practices limit the effectiveness of budgets and often call for less than precise accounting methods. Bailey decided to estimate the budget maintaining the budget slack.

For each item on Bailey’s list, explain whether it will create budgetary slack. Use numerical examples as necessary to illustrate. 

Use the top quartile for all wage and salary categories

This will contribute to slack unless the average of all workers in her department are in the top quartile of wages and salaries. This can be especially troublesome if she knows the average wages and salaries of her department are near the lower end of the range.
However, this is also something that could be easily detected through variance analysis of the labor rate variance. The amount of slack will depend on the known difference between the actual average and the top quartile average.

Select the optimistic values for the estimated production ranges for the coming year. These are provided by the marketing department

If the optimistic operating range has a reasonable chance of being achieved this would not be considered an unethical base. Evaluation variances with a static budget normally do not detect volume differences, and this could easily result in budgetary slack.

Use the average of the three months in the current year with poorest production efficiency as benchmarks of success for the coming year.



When discussing performance measurement as it relates to being a tool for management decision making. Misunderstanding the uses of performance measurement data, especially when applied to budget preparation, can cause catastrophic results to program areas. One of the greatest mistakes is to make simplified assumptions based on misapplied evaluations or unrefined results, then apply that data to budgetary decisions, especially when considered as part of a performance measurement based system of rewards and punishments. Using the worst performance periods as a base for the coming year would provide for slack in the budget unless the poor performance tends to repeat itself from time-to-time.

Base equipment charges (primarily depreciation) on replacement values furnished by the purchasing department.



If replacement values are used for planning, then replacement values would have to be used for evaluation purposes. If used consistently according to generally accepted accounting principles, this would not generate slack.

Base other fixed costs on current cost plus an inflation rate estimated for the coming year.



If the fixed costs are discretionary, it is appropriate to use the current amount with adjustments for inflation. However, committed fixed costs, such as a ten-year lease of equipment, would create budgetary slack and would be an unethical practice.

Use the average of the ten newly hired employee’s performance as a basis of labor efficiency for the coming year.



If the department 's employees normally experience a learning curve in their production activities, it would create slack if most of the department 's employees have already achieved relatively high levels of job skills. However, if the department has high employee turnover or if most of the department 's employees are new, this would not be an unreasonable assumption.

Given the company’s use of static budgets as one of the performance evaluation measures of its managers, can the managers justify the use of built-in budgetary slack?



No, anything that purposefully distorts the results of operations cannot be justified. If the managers are not being fairly evaluated with the static budget, they should recommend to the top executives that the system be changed. Just because they have always used a static budget approach does not mean that it cannot be changed.

What would you recommend as a means for Bailey to improve the budgeting situation in the company? Provide some specific examples of how the budgeting process might be improved



She could recommend several measures to top management that would improve the reporting system.

o

These include:



Change from a static to a flexible budgeting system.



Allow the department managers to have input into the planning process with appropriate justifications for the amounts submitted.



Separate variance analysis into fixed and variable categories.



Separate variance analysis into controllable and uncontrollable categories.



Have investigations of all variances outside a certain range such as plus or minus 2 percent. References



Al L. Hartgraves, Wyane J. Morse, Managerail accounting (2014). Operational
Budgeting and Profit Planning (pg.315). Cambridge Business Publisher.

References:  Al L. Hartgraves, Wyane J. Morse, Managerail accounting (2014). Operational Budgeting and Profit Planning (pg.315). Cambridge Business Publisher.