Question

Allenby Ltd is a distributor of earrings to various retail outlets located in shopping malls across the country. The company operates on a financial year basis and begins its annual budgeting process in late March when the Chief Executive Officer (CEO) establishes targets for total sales dollars and net operating income before taxes for the next financial year.

The sales target is given to Marketing Department, where the Marketing manager, Ms Dory Thompson formulates a sales budget in both units and dollars. Ms Thompson also estimates the cost of the marketing activities required to support target sales volume and prepares a tentative marketing expense budget.

The Deputy CEO uses the sales and profit targets, and the tentative marketing expense budget to determine the dollar amounts that can be devoted to purchases and office expense. The Deputy CEO prepares the budget for office expenses, and then forward to the Purchases Department, the sales budget in units and total dollar amount that can be devoted to purchases. The purchases manager is Mr Mark Treble.

The purchases manager develops a purchases plan that will acquire the required inventory units when needed within the cost constraints set by the Deputy CEO. The budgeting process usually comes to a halt at this point because the purchases manager does not consider the financial resources allocated to his department to be adequate.

When this standstill occurs, the Chief Finance Officer (CFO), the Deputy CEO, the marketing manager, and the purchases manager meet to determine the final budgets for each of the areas. This normally results in a modest increase in the total amount available for inventory costs, while the marketing expense and office expense budgets are cut. The total sales and net operating income targets proposed by the CEO are seldom changed. Although the managers are hardly pleased with the compromise, these budgets are final. The marketing and purchases managers then develop a new detail budget for their own departments.

However, none of these departments has achieved their budgets in recent years. Sales often run below the target. When budgeted sales are not achieved, each department is expected to cut costs so that the CEO’s profit target can still be met. Nonetheless, the profit target is hardly met since costs are not cut enough. In fact, costs often run above the original budget in all departments.

The CEO is concerned that the company had not been able to meet its sales and profit targets. He employed a consultant with considerable relevant industry experience. The consultant suggested a participatory budgeting approach where the marketing and production managers would be requested by the CEO to coordinate in order to estimates sales and purchases quantities.

Ms Thompson decided that she would start out by looking at recent sales history, potential customers, and customers’ spending patterns. Subsequently, she would intuitively forecast the best sales quantity and pass it to Mr Treble so he can estimate a purchases quantity.

Since Ms Thompson and Mr Treble did not want to fall short of the sales estimates, they gave themselves ‘a little breathing room’ by lowering the initial sales estimates by between 5% and 10%. As a result, they had to adjust the projected purchases as the year progressed, which changes the estimated ending inventory. They also made similar adjustments to expenses by adding at least 10% to the initial estimates.

Prepare a report to the CEO discussing the follow aspects.

1. The company’s original budget approach that contributed to the failure to achieve the CEO’s sales and profit targets.

2. Whether the departments should be expected to cut their costs when sales volume falls below budget.

3. The new budget approach recommended by the consultant.

4. Ms Thompson and Mr Treble behaviour under the new budget approach, and the potential impact of their behaviour.

help with part 4

Answer 1

1) The company's original budget approach that contributed to the failure to achieve the CEO's & profit targets because sales often run below target, when budgeted sales are not achieved each department is set to cut costs so that the CEO's profit target can some how be met, yet the profit target are hardly met since costs are not cut enough,some times cost runs above the budget.

2)Yes the departments should cut the costs when sales volume fall below budget as this might help their yearly efforts to yield the minimum marginal profits which the employees were employed for the whole financial year. The dividend can be of the cost value also what the company has invested .

3) For the new budget the consultant approached a new budgetary look where the marketing & production manager would be requested by the CEO's to ccordinate in order to estimate  sales & purchase quantity, by looking at the sales history, potential customers & customers spending patterns.

4) Their estimates will be not to fall short with sales estimates as Ms Thompson & Mr Treber gave themselves a little breathing room by lowering the sales estmates by between 5% to 10% . This resulted that they had to adjust the projected purchase as the year progressed.Which changes the estimated ending inventory. Same changes were made with the expenses by adding 10% to the initial estimates.