Management Accounting

Question

Five years ago, Phil Davis left his position at a large company to start Integrated Solutions Co. (ISC), a software design company. ISC's first product was a unique software package that seamlessly integrated networked PCs. Robust sales of this initial product permitted the company to begin development of other software products and to hire additional personnel. The staff at ISC quickly grew from three people working out of Davis's basement to over 70 individuals working in leased spaces at an industrial park. Continued growth led Davis to hire seasoned marketing, distribution, and production managers and an experienced accountant, Jan Smith.

Recently, Davis decided that the company had become too large to run on an informal basis and that a formalized planning and control program centered on a budget was necessary. Davis asked the accountant, Jan Smith, to work with him in developing the initial budget for ISC.

Davis forecasted sales revenues based on his projections for both the market growth for the initial software and successful completion of new products. Smith used this data to construct the master budget for the company, which he then broke down into departmental budgets. Davis and Smith met a number of times over a three-week period to hammer out the details of the budgets.

When Davis and Smith were satisfied with their work, the various departmental budgets were distributed to the department managers with a cover letter explaining ISC's new budgeting system. The letter requested everyone's assistance in working together to achieve the budget objectives.

Several of the department managers were displeased with how the budgeting process was undertaken. In discussing the situation among themselves, they felt that some of the budget projections were overly optimistic and not realistically attainable.

Required

1. How does the budgeting process Davis and Smith used at ISC differ from recommended practice?

2. What are the behavioral implications of the way Davis and Smith went about preparing the master budget?