A budgeting approach that leads to action.

Author:Bushong, J. Gregory
Position:Academic perspectives
 
FREE EXCERPT

Most organizations use budgeting to plan, monitor, and evaluate their operations. Developing realistic budgets and comparing the budget plan to the actual results consumes a significant amount of time and resources. By casting budgets in terms of traditional absorption costing and analyzing deviations from static budgeted amounts, many organizations fail to realize the full potential benefit of this process. This article examines the budgeting process at a Kentucky distillery to illustrate how economic realities such as changes in sales volume, cost, and price provide much more managerial information if they are analyzed formally in terms of deviations from budgets prepared in terms of throughput income.

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In the Sept. 2, 2003 issue of the Wall Street Journal, author Kimberly Palmer states that "Like country boys squeezed uncomfortably into tuxedos, bourbon makers have long felt like wallflowers beside glitzy vodkas and scotches that dominate the domestic spirits market. But now, at least in Europe and Japan, bourbon is coming into its own."

Bourbon makers, of course, have reason to shift their focus overseas. Sales in the United States fell about 38 percent during the last two decades. During the same period, however, sales in Japan, France, Australia, Spain and Italy more than doubled. Impact Databank Research reported that the United States made up 91 percent of the overall bourbon sales in 1985 but only 64 percent in 2001. In addition, there are signs of a demographic shift among bourbon drinkers. In bourbon tastings across the country, 30 to 40 percent are now women compared to 15 percent five years ago. (1)

From a budgeting standpoint, such events and their impact on corporate profits are usually handled from an intuitive standpoint. The purpose of this article is to argue that economic realities such as changes in sales volume, cost initiatives and price provide much more managerial information if they are analyzed formally in terms of deviations from budget. This article examines this contention by examining the budgetary process at a Kentucky distillery.

The Company

Old Bloomfield Distiller, located in scenic central Kentucky, manufactures a six-year-old 90 proof bourbon under the distillery name. In addition to the bourbon, Old Bloomfield produces an 80 proof gin and a similar vodka. The production and administrative facilities are contained in one location in Bloomfield, Kentucky. The existing reporting system provided a traditional absorption costing income statement (Example 1) where overhead was applied to production based on material consumption. Although direct labor was traced directly to the product lines, management was cognizant that the tracing was highly inaccurate due to the shifting of workers among the three products and the use of common facilities. The products were marketed through wholesale distributors via a sales force that works solely on a 5 percent commission basis. The remaining selling and administrative costs were allocated to the product lines based on sales dollars. Old Bloomfield's inventories do not vary significantly from year to year. (2)

The problem with Example 1 is that it is difficult to formally evaluate deviations from budget in terms of volume, price and cost control because no attempt is usually made to prepare flexible budgets in the aggregate. As a result, deviations from static budgets developed at the beginning of the year are usually visceral or intuitive. By reformulating the income statement, however, in terms of cost behavior, the deviations from budget can be explained in terms of volume, price and cost.

Example 2 illustrates a reformulation under the arguable assumption that the only variable costs within the company are materials and commissions. Some companies may have other variable...

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