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The Budgeting Process Adopted by HK Corporation - Case Study Example

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This case study "The Budgeting Process Adopted by HK Corporation" analyzes the budgeting process of HK Corporation, its main problems and gives recommendations regarding accounting techniques. …
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The Budgeting Process Adopted by HK Corporation
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Accounting Table of contents Part 3 Part-2 4 Part-3 5 Part-4 6 Part-5 (a) 7 Part-5(b) 9 Reference 11 Part The budgeting process adopted by HK Corporation suffers with many loopholes. At present the company is using actual costing process where different departments have to set their own budget as per the sales and profit margin target. The main problem is there is no standard to measure efficiency of each department on monthly basis. As explained by the consultant, though the sales budget, operation budget and the marketing expanse budget all are correctly planned, still the company failed to achieve its sales and profit target. This indicates that the plans were not well executed due to lack of coordination among different departments. In real situations cost cutting and retaining higher quality standards both are not possible together. When the departments were asked to make their plans, they were unaware of individual budgeted amount, so again the whole process has to be repeated which resulted in loss of time and resources. This reflects the department are not aware what is happening in the other departments and the whole system is misbalanced. For attaining the sales targets, proper marketing strategies should be used. As the company cut the allotted budget, marketing plan gets disturbed. And volume of sales falls below the target. The budgets of other departments are completely dependent on the sales target, so when sales volume decline, it disturbs operation of other department simultaneously. Profit of the company is not solely dependent on sales volume; other expanses like operational (cost labour, material, wages and overheads) and non-operational costs have direct influence on the profit margin. As HK Corporation’s sales declines, it has to reduce the production rate. Hence due to marginally affect fixed cost per unit goes high and profit per unit goes down. Management never took any initiative to understand the reasons behind such situations. When the management founds performance of any department is not as per the budget, they ask for an explanation. So the line manages have to review all historical data and have to find out an appropriate reason for deviation in cost and below standard performance of the department. These activities waste a lot of time and energy of line managers and they can pay less attention on the present operation of their department. Departments receive insufficient information regarding performance of other department, so they can’t take any pro-active actions which affects their own performance as well as departmental expanse. As a result HK Corporation fails to achieve its sales and profit targets. Part-2 To correct the prevailing problem in HK, its budgeting process has to be modified. First of all transparency within the corporation’s working environment has to be enhanced. Each and every department should be informed about current state of the others. This will improve the decision making process of line managers. They will be aware of future situations and can take pro-active actions so that performance of their department does not get hampered. In HK Corporation, budgeting is an annual phenomenon, the company set the annual budget for different department which has to use as standards. The actual performances are measured against it to find out deviation. Such budgeting technique does not consider changing market conditions and production and sales process suffers. To improve the condition in the company, flexible budgeting technique should be introduced. Use of rolling budget can also improve the problem associated with traditional budgeting process. The company’s sale comprises of both standard as well as customised items, so company will be benefited if they shift to activity based accounting techniques. This will assist in monitoring the cost on base of activities and profit margins can be easily monitored. Part-3 It is not advisable to cut the cost of functional areas when sales volume falls below the budget. All departments set their annual budgets keeping sales targets as the base. Other functional departments put a lot of time and labour in finalising their annual budget. If the sales fall below the targets, this information should be given to other departments as fast as possible so that they can bring the required change in their planning. For example production department should be asked to reduce production rate, automatically expanse of purchase department well go down. But change in marketing budget can further affect the future sales. Hence when the sales volume falls below target, instead of cutting expanse of functional department, change should be incorporated in the annual budget with in-depth planning. If the management cut cost budget of purchase department without change in production rate, it might happen that stock of raw material goes below the safety margin and production come to halt. So for few days the production stops, but company have to go on paying for fixed cost and as a result total cost of production goes up. On the other hand when production comes to halt, purchase department will make purchase in an unplanned manner which might end by paying higher cost for raw material and expanse of purchase department also goes high. Hence there must be a well planed strategy before any vital decisions are taken. Part-4 The conversation between Ali and Adam disclosed many hidden facts regarding HK Corporations standard cost and reporting system. Considering these conversation as base it can be concluded that motivational level of both the production and purchase manager is low. A part of their payment is directly related with department’s performance. This strategy was adopted so that managers will control the department efficiently and meet the standards. But due to loopholes in company’s budgeting strategy, performance of all departments has fallen below standards. And now for deviation they have to give explanation. They feel victimised and they highly de-motivated. They know the top management is less bothered to know the true cause behind poor performance of the department, so they try to hide all vital information and present some fake causes. Their behaviour reflects they are less bothered for welfare of the company and are more interested in eager to give fake excuses so that their salary does not get affected. Part-5 (a) Standard costing is often used by the companies to set standards for their production process. The budgets are set for a single unit’s production. While calculating cost management uses the suggestions from different departments. This process have many benefits, few of them are discussed below: The standards costs are used as ideal costs while setting the expanse budgets for different departments. The manager continuously monitors their department’s performance while comparing the actual cost against the standards. The deviation assists them in flinging the reason behind such deviation. Hence it acts as a yardstick for measuring the performance of different department. This accounting technique provides vital information and after analysing them, management can identify those areas which require more attention and modification. These standards are quite useful for setting not only budgets, but also prices and production schedules. The firms have accepted the fact that this technique simplifies record keeping technique and stock valuation procedures. For any system or technique to be successful, it needs to be accepted by its employees. As the standard accounting process brings transparency within the whole process, hence it motivates the employees and makes them more cost conscious. Use of standards helps employees to set target of efficiency and to achieve them. Considering all these advantages it can be concluded that proper implementation and use of standard costing benefits the company as they enhance their performance by better standards setting and constant monitoring (Kaplan & Cooper, 1998, p.29-37). Part-5(b) At present the main cause behind company’s poor performance is its faulty standard costing techniques and variance reporting system. At present the company is using an annual budgeting process. They waste lots of time and effort but at the end they fail to achieve their sales and profit targets. If the management want to improve the present state, they first have to conduct an in-depth analysis to find out the hindrances that obstruct the company from having a smooth ongoing process. Then the management should ask employees from different department to participate in solving the problems. HK Corporation should redesign their standard cost for per unit. The company is manufacturing certain standard products so it is easy to set standard cost for them, but problem lies with those units which have to be manufactured as per customers’ specification. Using the past experience as a standard, a rough estimate can be made. The company have to shift toward a flexible budget instead to maintain an annual budget. This flexible budget should be revised on an annual basis to incorporate any changes taking in the market place. Information should be communicated to all the departments so that each one knows that is going in the other departments. Performance of a department should be appraised on basis of monthly budget instant of using the annual budget. Change in cost of raw materials, labour rates or change in any other factor of production should be used to revise the standard costs on regular basis (monthly or quarterly). Management should understand the fact that company considers the changes in their accounting techniques so that pro-active actions can be taking and the company can set more realistic targets. Once the sales and profit targets get achieved, it will further boost employees confident and they will participate more actively in budget setting process. Reference Kaplan, S. R. & Cooper, R. 1998. Cost & effect: using integrated cost systems to drive profitability and performance. 3rd ed. Harvard Business Press. Read More
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