Drury (2004) suggests that the principal budget factor is the factor that limits the organisation’s performance in the budget period. For example, this could relate to the lack of resources in the organisation to meet the demand for the product. The lack of resources could relate to materials, machine capacity, or labour.
As the maintenance department manger has said, due to the department’s attempts to achieve the budget they are ignoring important maintenance of machinery which is a limiting factor in production. This could have an effect upon sales and revenue throughout Trescothick Ltd because if the maintenance of important machinery is being overlooked, then the manufacturing of the industrial machinery produced shall be delayed or even disregarded completely. Thus, customers will not be able to purchase the product off Trescothick Ltd, or deliveries may be delayed which could damage the goodwill of the company and/or could eventually drive customers to competitors.
Performance Evaluation
The current budgetary control system consists of a preparation of a monthly performance report which compares actual costs with budget costs. This method of performance evaluation has a high reliance on accounting performance measures (RAPM). It can also be described as a budget-constrained style. Hopwood (1976) cited by Drury (2005) describes a budget-constrained style of performance evaluation as the criterion of performance being stressed at the expense of other valued and important criteria, and a cost centre head will tend to receive an unfavorable evaluation if his/her actual costs exceed budgeted costs. Therefore, managers, as seen with the assembly manager in this case will compromise other responsibilities in order to meet the budget because their individual performance is measured in this way.
In terms of Trescothick Ltd, both the assembly manager and the maintenance manager are guilty of this. The above two sections can both be linked in here. Product quality is being overlooked in the assembly department and important maintenance work is being overlooked in the maintenance department. Things will only get worse from here. The managers in both departments are meddling with their responsibilities in order to meet the budget. Thus, if one department struggles to reach their budget for a certain month and the manager decides to manipulate quality or production, etc in order to succeed in meeting the budget, then the following month’s budget will be even more difficult to reach because of the ‘tightening’ system that is currently employed. To succeed in maintaining the budget, manipulation will take place again meaning that the quality of the product, maintenance of machinery and even employee morale and motivation will decline even further. Hostility towards the budget may soon appear. When using this method of budgeting, as Hopwood (1976) stated, budget data are used in a rigid manner in performance evaluation.
Hopwood’s research in this field is in agreement with Argyris’ research that was conducted in 1952. Argyris (1952) found that supervisions in his study perceived budgets as sources of pressure and tension. He suggested that although budgetary controls can prevent dysfunctional behaviour, they may also lead to dysfunctional behaviour.
Research into RAPM assumes that the exercise or inappropriate use of RAPM in performance evaluation motivates the subordinated to manipulate accounting data and/or engage in counter productive behaviour.
Recommendations
Performance Evaluation and Long-Term Objectives
Under the current system managers feel under great pressure to achieve the budget due to the performance evaluation report that is prepared monthly. The current system is concerned with short-term planning rather than the long-term objectives of the organization. Trescothick Ltd may benefit from a budgetary control system that works towards the long-term objectives of the organization. This may improve the efficiency of the company as a whole, and short-term planning could be implemented form here. One way to establish this new budgetary aim is to change the style of the performance evaluation report. The current evaluation report has an emphasis on high RAPM. If the organization changed their approach to performance evaluation, then a profit-conscious style, with less emphasis on RAPM, could be put in place. Hopwood (1976) cited by Drury (2005) gives a brief outline of a profit-conscious approach:
The performance of the cost centre head is evaluated on the basis of his/her ability to increase the general effectiveness of his/her unit’s operations in relation to the long-term goals of the organization. One important aspect of this at the cost centre level is the head’s concern with the minimization of long-run costs. The accounting data must be used with some care in a rather flexible manner, with the emphasis for performance evaluation in contributing to long-term profitability.
This style of performance evaluation still puts an emphasis on lowering costs, as well as aiming to maximize profitability in the long-run whilst working towards the long-term objectives of the organization.
Participation
Allowing managers to participate in the creation of budgets can have an extremely positive effect on their attitude towards the budget, and therefore, improve the chances of the budget being legitimately met. Drury (2005) stated that the managers who are responsible for meeting the budgeted performance should prepare the budget for those areas for which they are responsible. The preparation of the budget should be a ‘bottom up’ process. This means that the budget should originate at the lowest levels of management and be refined and coordinated at higher levels. The justification for this approach is that it enables managers to participate in the preparation of their budgets and increases the probability that they will accept the budget and strive to achieve the budget target.
The current performance evaluation report is based upon a high RAPM. Research has shown that, in this situation, budget participation is likely to lead to higher subsequent performance. The recommended performance evaluation style will still involve a degree of RAPM, although not to the extent of the current system. However, participation is an excellent method to help the budgetary control system be a success, therefore it should be implemented when preparing future budgets.
‘Tightening’ Method
When the company decides to ‘tighten’ the budget, it may be worth taking into account certain considerations for example environmental aspects, and costs that are out of management control before issuing a sterner budget for the forthcoming month.
Conclusion
Thus, the company needs to study the current budgetary control system and take note of the serious problems it is causing not only in departments, but throughout the whole of the organization in terms of product quality, decisions on workload and general morale and motivation amongst staff within the company. Corrective action needs to be taken to improve the current system and my recommendations of changing the performance evaluation style and the participation of managers when preparing the budget should be thoroughly considered.
References
Argyris, C. (1952). The Impact of Budgets on People. New York, Controllership Foundation.
Drury, C. (2004). Management and Cost Accounting, 6th edition. London. Thompson Learning.
Drury, C. (2005). Management Accounting for Business, 3rd edition. London. Thompson Learning.
