CASE 928 Evaluating a Company's Budget Procedures [LO 91]

Tom Emory and Jim Morris strolled back to their plant from the administrative offices of Ferguson & Son Manufacturing Company. Tom is manager of the machine shop in the company's factory; Jim is manager of the equipment maintenance department.

The men had just attended the monthly performance evaluation meeting for plant department heads. These meetings had been held on the third Tuesday of each month since Robert Ferguson, Jr., the president's son, had become plant manager a year earlier.

As they were walking, Tom Emory spoke: Boy, I hate those meetings! I never know whether my department's accounting reports will show good or bad performance. I'm beginning to expect the worst. If the accountants say I saved the company a dollar, I'm called Sir, but if I spend even a little too muchboy, do I get in trouble. I don't know if I can hold on until I retire.

Tom had just been given the worst evaluation he had ever received in his long career with Ferguson & Son. He was the most respected of the experienced machinists in the company. He had been with Ferguson & Son for many years and was promoted to supervisor of the machine shop when the company expanded and moved to its present location. The president (Robert Ferguson, Sr.) had often stated that the company's success was due to the high-quality work of machinists like Tom. As supervisor, Tom stressed the importance of craftsmanship and told his workers that he wanted no sloppy work coming from his department.

When Robert Ferguson, Jr., became the plant manager, he directed that monthly performance comparisons be made between actual and budgeted costs for each department. The departmental budgets were intended to encourage the supervisors to reduce inefficiencies and to seek cost reduction opportunities. The company controller was instructed to have his staff tighten the budget slightly whenever a department attained its budget in a given month; this was done to reinforce the plant manager's desire to reduce costs. The young plant manager often stressed the importance of continued progress toward attaining the budget; he also made it known that he kept a file of these performance reports for future reference when he succeeded his father.

Tom Emory's conversation with Jim Morris continued as follows:

Tom:

I really don't understand. We've worked so hard to meet the budget, and the minute we do so they tighten it on us. We can't work any faster and still maintain quality. I think my men are ready to quit trying. Besides, those reports don't tell the whole story. We always seem to be interrupting the big jobs for all those small rush orders. All that setup and machine adjustment time is killing us. And quite frankly, Jim, you were no help. When our hydraulic press broke down last month, your people were nowhere to be found. We had to take it apart ourselves and got stuck with all that idle time.

Jim:

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I'm sorry about that, Tom, but you know my department has had trouble making budget, too. We were running well behind at the time of that problem, and if we'd spent a day on that old machine, we would never have made it up. Instead we made the scheduled inspections of the forklift trucks because we knew we could do those in less than the budgeted time.

Tom:

Well, Jim, at least you have some options. I'm locked into what the scheduling department assigns to me and you know they're being harassed by sales for those special orders. Incidentally, why didn't your report show all the supplies you guys wasted last month when you were working in Bill's department?

Jim:

We're not out of the woods on that deal yet. We charged the maximum we could to other work and haven't even reported some of it yet.

Tom:

Well, I'm glad you have a way of avoiding the pressure. The accountants seem to know everything that's happening in my department, sometimes even before I do. I thought all that budget and accounting stuff was supposed to help, but it just gets me into trouble. It's all a big pain. I'm trying to put out quality work; they're trying to save pennies.

Required:

Identify the problems that exist in Ferguson & Son Manufacturing Company's budgetary control system and explain how the problems are likely to reduce the effectiveness of the system.

Explain how Ferguson & Son Manufacturing Company's budgetary control system could be revised to improve its effectiveness.

The case for Chapter 9 comes from the fact pattern in Case 9-28 on pages

414-415 of your eBook. Please use the fact pattern as a resource for preparing your memo. There are no numbers to analyze in this case, although I have included condensed comparative statements of operating income for Ferguson & Son Manufacturing Company for the last five years to give you a sense of the Companys size.

Ferguson & sons manufacturing company

Operating income for five years ending December 31, 2015 (000s)

	2015	2014	2013	2012	2011
sales	$12,205	$11,735	$11,677	$11,561	$11,678
cost of goods sold	$5,858	$5,281	$5,266	$5,168	$5,255
gross profit	$ 6,346	$ 6,454	$ 6,411	$ 6,393	$ 6,423
operating expenses	$ 2,368	$ 2,335	$ 2,335	$ 2,324	$ 2,336
operating income	$ 3,979	$ 4,119	$ 4,075	$ 4,070	$ 4,087

You have been retained by Robert Ferguson, Sr., President of Ferguson &

Son Manufacturing Company, to review the budgeting process and make recommendations on how it might be improved. He is concerned that both the quality of the products produced and employee morale have deteriorated over the past couple of years.

Prepare a memo to Robert Ferguson, Sr. identifying the budget control system weaknesses and explain their impact on the operations of the Company. Make recommendations on how the budget control system could be improved to achieve appropriate product quality and improve employee morale.

What are the Companys goals and how well are they communicated to managers and employees?

What factors do managers have control over and how does this relate to the monthly budget reports?

Do budget reports contain useful information?

Do budget reports encourage cooperation between departments?

Does the budgeting process encourage a long-term perspective?

What is the focus of the monthly budget reports?

Does the budgeting process motivate people and encourage coordination between departments?