Adamsville Industries manufactures and sells recreation vehicles. The company has eight divisions strategically located near major markets. Each division has a sales force and two to four manufacturing plants. Divisions operate as autonomous profit centers responsible for purchasing, operations, and sales.
Dale Collins, the corporate controller, described the divisional performance measurement system as follows: "We allow divisions to control the entire operation from the
purchase of raw materials to the sale of product. We at corporate headquarters get involved only in strategic decisions, such as developing new product lines. Each division is responsible for meeting its market needs by providing the right products at a low cost on a timely basis. Frankly, the divisions need to focus on cost control, delivery, and services to customers to become more profitable.
"While we give divisions considerable autonomy, we watch their monthly income statements very closely. Each month's actual performance is compared with the budget in considerable detail. If the actual sales or contribution margin is more than 4% or 5% below the budget, we jump on the division people immediately. I might add that we don't have much trouble getting their attention. All of the management people at the plant and division level can add appreciably to their annual salaries with bonuses if their actual profit is considerably greater than budget."
The budgeting process begins in August when division sales managers, after consulting with their sales personnel, estimate sales for the next calendar year. These estimates are sent to plant managers, who use the sales forecasts to prepare production estimates. At the plants, production statistics, including raw material quantities, labor hours, production schedules, and output quantities, are developed by operating personnel. Using the statistics prepared by the operating personnel, the plant accounting staff determines costs and prepares the plant's budgeted variable cost of goods sold and other plant expenses for each month of the coming calendar year.
In October, each division's accounting staff combines plant budgets with sales estimates and adds additional division expenses. "After the divisional management is satisfied with the budget," said Collins, "I visit each division to go over its budget and make sure it is in line with corporate strategy and projections. I really emphasize the sales forecasts because of the volatile demand for our product. For many years, we lost sales to competitors because we didn't project high enough production and sales, and we couldn't meet the market demand. More recently, we were caught with large excess inventory when the bottom dropped out of the market.
"I generally visit all eight divisions during the first two weeks in November. Then the division budgets are combined and reconciled by my staff, and they are ready for approval by the board of directors in early December. The board seldom questions the budget.
"One complaint we've had from plant and division management is that they are penalized for circumstances beyond their control. For example, they failed to predict the recent sales decline. As a result, they didn't make their budget and, of course, they received no bonuses. However, I point out that they are well rewarded when they exceed their budget. Furthermore, they provide most of the information for the budget, so it's their own fault if the budge is too optimistic."
Required:
Discuss the following:
(1) Biases that corporate management should expect in the communication of budget estimates prepared by its division and plant personnel
(2) Sources of information that corporate management can use to monitor the budget estimates prepared by its divisions and plants
(3) Services that corporate management can offer the divisions to aid them in their budget development, without appearing to interfere with division budget decisions
(4) Factors that corporate management should consider in deciding whether to become more involved in the budget process