Budgets serve five main purposes; planning, facilitating communication and coordination, allocating resources, controlling profits and operations and evaluating performance and providing incentives. The budgeting process requires both technical and interpersonal leadership skills to achieve each of these purposes effectively. The director’s memo demonstrates several short comings in the budgeting process. The director instituted the “responsibility accounting system” as a means of evaluating performance. However, the DPW director has not consulted Sam in the budget process. Sam understands that his total expenditures are impacted by relatively unpredictable events that contribute to an uncontrollable element of his cost. The frequency, amount, and duration of snow storms are the underlying cost drivers for Sam. Sam can optimize his practices to minimize costs at different levels of snow storms’ to reduce overall costs. Optimizing the processes includes: developing the most efficient routes, creating the right balance of regular wage and overtime, and prudent use of salt and sand. Despite his ability to optimize, his cost variance is ultimately impacted by the level of ‘snow storm’ factors. The director should focus on working with Sam to increase process efficiency, and hold him accountable for operating within this budget for each level of activity. Sam’s budget is overwhelming seasonal. Dividing the yearly budget by four does not reflect Sam’s costs per quarter accurately. There are off-season cost that may impact snow removal: training, procuring and managing supplies, and maintenance. If these activities exist, they should be reflected separately in the budget. Sam should be evaluated on budgets developed for each quarter. The director’s 3% reduction in costs, as opposed to using a three-year moving average, presents several issues. The 3% reduction is meant to motivate the supervisors. However, this forecast is unrealistic without deflation, and in this case, considering the upward trend in labor and material costs. Budgeting based on a moving average would allow the director to monitor costs using a moving average control chart. Although this method only alerts the director after the “out of control” month occurred, it does help him understand the difference between noise and signal variance, and thus helps him allocate his time when managing by exception. There are also advantages of the method. It is better for each department to switch from infrequently reporting to frequently reporting. Frequent reporting could help department heads understand their costs and make budgets based on more reliable cost drivers. Through frequent reporting and budgets, departments could better plan and allocate the resources, control operations and evaluate performance. 1. The flexible budget for a service company applies the standard rate of the cost driver to the actual level of business activity. Plow hours is the best cost driver to use for the variable expenses, which include the cost of drivers, supplies, fuel, and maintenance. The predetermined overhead rate for drivers, supplies, maintenance and fuel was calculated by dividing the actual and budgeted cost by 1175 plow hours and 1000 plow hours respectively. Plow hours were determined by multiplying the actual and budgeted cubic miles of snow plowed by 47 min/cubic mile and 48min/cubic mile respectively, and dividing that number by 60 minutes to convert minutes into hours.
Table [ 1 ] Overhead Rates
The flexible budget below shows that the variance is significantly lower based on plow hours as a cost driver. Driver’s costs were still lower than the actual amount incurred however, which suggests that Sam made a grave error when he lowered his estimates for the costs of doing business. Sam still underestimated his driver’s costs when accounting for the increase in business activity, which means that the predetermined rates that he uses to...
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