Second, selling conditions often changed substantially after the budget was adopted, but there was no provision for making the proper corresponding changes in the selling expense budget. As a means of overcoming these weaknesses the president suggested the possibility of setting selling cost budget standards on a fixed and variable basis.
Analysis and Interpretation of Available Data
The controller was convinced that the fixed portion of selling expenses-the portion independent of any fluctuation in sales volume-could be established by determining the amount of expenses that had to be incurred at the minimum sales volume at which the company was likely to operate. He decided that the variable portion of the selling expense standard should be expressed as a certain amount per sales dollar and believed that a budget varied with sales would certainly be better than a budget that did not vary at all.
As a basis for setting the variable expense standards, using linear regression, the controller determined a series of equations that correlated actual annual expenditures for the principal groups of expense items for several preceding years with sales volume. At this point the controller had both a rate of variation and one point on a selling expense graph for each expense item.
From the information given in Exhibit 1 and 3, we have determined each item of expenses:
a) variable with sales volume
b) partly variable with sales volume
c) variable with some other factors
d) not related to output volume at all.
The most appropriate type of budgeting system for this company is incremental budgeting. Why?
- In preparing the annual budget management set up their expenses as fixed in during year, but year to next the company considers cost variation with sales volume.
- Management tends to approve changes that correspond to anticipated changes in sales volume. That is, for allowing additional personnel when volume is expected to increase and for layoffs w when volume is expected to decrease.
- Budgeted selling expenses reflect the expected volume fluctuations in short run even if budgeted expenses are not adjusted in accordance with actual sale. It is uneconomical for them to adjust the workforce for short run fluctuations, for example, hiring and training personnel for short-run needs too expensive and temporary layoffs hurt morale.
The proposed sales expense budgeting system shouldn’t be adopted.
- The budget committee, underlying the final figures cares about only increases sales volume. Making only minor changes before approval budgeting, they don’t analyze the causes of increasing and decreasing costs.
- Time and money consuming and more complex
We know from the case that the controller needed to study of selling expenses to devise a method of setting reasonable standards for several years in order to make analyses for selling costs. We think that is more complex and time, money consuming.
- Manufacturing costs differs from sales expenses
The President of the company as so he had worked in manufacturing department, used to charge with the lowest possible consumption of resources, that was indicator of efficiency. While for sales department, the minimization of their costs it will be indicator of inefficiency. With increase sales volume spontaneously will increase expenses. As so sales increase, so will purchases raw materials, and require more labor and equipment, and while higher sales result in higher taxable income and thus taxes. The company will need more in advertising expense. But their expenses will be covered by sales revenue that leads to profit.
- Current budgeting system doesn’t show any fluctuations of sales volume. It causes changes of sales expenses but provides information that company can afford to spend less or more on advertising.
- The difference between budgeted and actual expense is not a measure of efficiency in a discretionary expense center. Is is simply the difference between the budgeted input and the actual input. It is no measure the value of the output. By definition the budget does not purport to measure the optimum amount of spending, we cannot say that living within the budget is efficient performance.
- In existing system management did not properly consider following items:
- Donations
- Light & Heat
- Advertisement
- Taxes
Conclusion
The management used the incremental budgeting, and after drew up the new selling expense budgeting by controller we think it neither incremental nor “Zero-Base Review” budgeting system.
Recommendations
The company should clear understand the engineered and discretional expenses in order to judge about efficiency and effectiveness. By the theory, efficiency the ratio of outputs to inputs, or the amount of output per unit of input. Effectiveness is determined by the relationship between a responsibility center’s output and its objective. From the case we have seen the center’s objectives differ from. Then they should add such item as Research and Development expense. It is investments in long run.
- The management should make forecast for the next year on the previous data
- Should distinguish engineered and discretional expenses more accurately
- Open R & D department in order to have long run profit
- Find the way of reducing the costs that will not reflect the volume of output
- Open new product line in order to reduce risks