ACCT 311 Week 5 Group Discussion Board Forum 3 Example

Group Discussion Board Forum 3: Activity-Based Costing and Master Budgeting

ACCT 311 Corporate Accounting, Group Discussion Board Forum 3

Thread by [Student Name]

The manufacturer, its plants and figures and the classmate are composites; the textbook, Scripture and the peer-reviewed sources cited are real.

A composite manufacturer of classroom desks and chairs runs three plants, and each fall its plant managers prepare their own cost budgets for the coming year. This year the Ohio plant budgeted $6.48 million in manufacturing costs to produce 120,000 units, while the two other plants, with similar equipment and product mix, ran about $50 a unit. At that rate the Ohio workload should cost about $6.0 million. The Ohio manager's bonus depends on beating the budget, and he has beaten it comfortably for three years running. The controller suspects about $480,000 of slack, roughly 8 percent.

Garrison et al. (2018) recommend self-imposed, or participative, budgets, prepared with the full cooperation of the managers who will be held to them. They argue that managers closest to operations have the best information for estimates, that people are more committed to targets they helped set and that a manager who misses a self-imposed budget has no one else to blame. The chapter also warns that self-imposed budgets need review by higher management, because a manager may build in slack to make the budget easier to meet, especially when the budget is used to evaluate performance.

Research suggests that the slack in Ohio is a product of how the budget is used, not of participation itself. Merchant (1985) surveyed manufacturing managers and found that those who participated more in setting their budgets reported a lower propensity to create slack, while a heavier emphasis on meeting the budget was associated with a greater propensity. In other words, participation and slack are not partners; slack grows when the budget becomes a pass-or-fail test tied to rewards. The Ohio manager is behaving exactly as the incentives suggest. The cure for padding is not to take the pen away from the plant manager but to stop making the budget a test he can win by writing it.

Practitioners have argued about this problem for years. Hansen et al. (2003) describe two responses to dissatisfaction with traditional budgets: one movement tries to improve the budgeting process itself, focusing on its planning problems, while the "beyond budgeting" movement proposes abandoning fixed budgets for performance evaluation, focusing on the incentive problems. For our manufacturer, a middle path seems sensible. Keep the participative budget for planning, since the plant managers know their operations best, but evaluate performance with flexible budgets and comparisons across the three plants, so that a manager cannot win simply by writing an easy target. The company could also share the cross-plant cost per unit openly during budget review, which would make an outlier like Ohio's estimate visible before the year begins. Finally, the bonus could reward accurate forecasting as well as cost control, so that a manager who budgets $6.0 million and spends $5.9 million earns more than one who budgets $6.48 million and spends $6.1 million.

Writing about the collection he was carrying to Jerusalem, Paul said he took care to be honorable before people as well as before God (English Standard Version Bible, 2001/2016, 2 Corinthians 8:21). A budget is a promise to colleagues about what a plant needs. Padding it may protect a bonus, but it misleads the people who allocate resources across the company, and it takes money that another plant could have used. A Christian manager can give an honest estimate and argue openly for a contingency if one is needed, which honors both standards Paul describes.

Reply to Andre

Andre, your post on activity-based costing explained how the furniture maker in your example found that its small custom orders were far more expensive than the traditional overhead rate suggested, once setup and engineering costs were traced to the orders that caused them. I think your ABC example could help with the budgeting problem in my thread. Garrison et al. (2018) describe how ABC assigns overhead to activity cost pools using activity measures such as setups, purchase orders or machine hours. If the plants budgeted by activity, the Ohio manager would have to explain his overhead in terms of how many setups, purchase orders and maintenance hours his plan required.

That would make padding much harder to hide. A lump-sum budget of $6.48 million is difficult to question, but a budget that requires 2,400 setups when the other plants need 1,800 for similar volume invites an obvious question. Activity-based budgeting turns the review into a conversation about specific activities rather than a negotiation over a total. It also connects to the product-cost issue you raised: if custom orders drive setups, then a plant that takes more custom work legitimately needs more resources, and the activity budget would show that too.

The trade-off is the cost of maintaining activity data. Balakrishnan et al. (2012) set four kinds of product costing side by side and note that each makes different trade-offs between accuracy and the effort required to keep it running. Do you think your furniture maker's ABC system could be reused for budgeting without much extra work, or would the activity rates need to be rebuilt each year as the product mix changes? If they do need rebuilding, the company might start with only the two or three activities that drive most of the overhead, such as setups and engineering changes, and leave the smaller pools on a simple rate.

References

Balakrishnan, R., Labro, E., & Sivaramakrishnan, K. (2012). Product costs as decision aids: An analysis of alternative approaches (Part 1). Accounting Horizons, 26(1), 1-20. https://doi.org/10.2308/acch-50086

English Standard Version Bible. (2016). Crossway. (Original work published 2001)

Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial accounting (16th ed.). McGraw-Hill Education.

Hansen, S. C., Otley, D. T., & Van der Stede, W. A. (2003). Practice developments in budgeting: An overview and research perspective. Journal of Management Accounting Research, 15(1), 95-116. https://doi.org/10.2308/jmar.2003.15.1.95

Merchant, K. A. (1985). Budgeting and the propensity to create budgetary slack. Accounting, Organizations and Society, 10(2), 201-210. https://doi.org/10.1016/0361-3682(85)90016-9