Advanced: Impact of aggregating budget estimates and budget bias Devonshire Dairies pic sells a range of dairy
Question:
Advanced: Impact of aggregating budget estimates and budget bias Devonshire Dairies pic sells a range of dairy products on a national basis through a direct sales force organized into four geographical regions. In December 1988 the sales director had received 1989 sales budgets from his tour regional managers, and was concerned that they appeared to represent very different standards of attainment. He also thought it unlikely that the national budget (i.e.
the sum of the four regional budgets) could be achieved, and so had made his own estimates of the sales revenue he expected each division to obtain, as shown below:
The sales director recognized that his estimates were subject to some uncertainty due to random events, and believed this could be adequately modelled by assuming that they represented the means of normal distributions having a standard deviation of £1 million for each region and that actual sales in each region were statistically independent of each other. However, he was reluctant to amend the budgets submitted to him as he could see the motivational advantages in letting each regional sales manager aim for a target which he had set for himself, and to which he was committed.
Requirements
(a) Calculate the probability of each sales region achieving at least the budget submitted by its regional manager, on the assumption that the sales director's model is correct Also calculate the probability that the total of the budget submissions will be at least achieved, and comment on your results. {10 marks)
(b) Discuss the reasons why managers may submit budgets that differ from their superiors' estimates of outcomes. What action would you recommend the sales director to take In this case? (8 marks)
(c) The company is considering implementing a system of performance-related pay whereby managers who achieve their annual sales budgets are rewarded by the payment of an annual bonus equivalent to one month's salary. Discuss the impact such a system could have on the operation of the budgeting system, and suggest ways in which the proposed bonus system could be amended to minimize any adverse effects.
Advanced: Advantages and disadvantages of participation and comments on a new performance measurement and evaluation system Incorporated Rnance pic is a finance company having one hundred branch offices in major towns and cities throughout the UK. These offer a variety of hire purchase and loan facilities to personal customers both directly and through schemes operated on behalf of major retailers. The main function of the branches is to sell loans and to ensure that repayments are collected; the head office is responsible for raising the capital required, which it provides to branches at a current rate of interest.
Each year branch managers are invited to provide estimates of the following items for the forthcoming year, as the start of the budgetary process:
Value of new loans (by category e.g. direct, retail, motor)
Margin percentage (i.e. loan rate of interest less cost of capital provided by head office)
Gross margin (i.e. value of new loans x margin percentage)
Branch operating expenses Net margin (i.e. gross margin less operating expenses)
The main branch expenses relate to the cost of sales and administrative staff, and to the cost of renting and maintaining branch premises, but also include the cost of bad debts on outstanding loans.
These estimates are then passed to headquarters by area and regional managers and are used, together with other information such as that relating to general economic conditions, to set an overall company budget. This is then broken down by headquarters into regional figures; regional managers then set the area budgets and area managers finally set branch budgets. However, a common complaint of branch managers is that the budgets they are set often bear little resemblance to the estimates they originally submitted.
Budget targets are set for the five items specified above, with managers receiving a bonus based on the average percentage achievement of all five targets, weighted equally.
Requirements
(a) Discuss the advantages and disadvantages of allowing managers to participate in budget-setting, and suggest how Incorporated Finance pic should operate its budgetary system. (15 marks)
(b) The managing director is considering changing the performance evaluation and bonus scheme so that branch managers are set only a net margin target. Prepare a report for him outlining the advantages and disadvantages of making such a change.
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