Panarude Airfreightis an international air freight hauler with more than 45 jet aircraft operating in the United States and the Pacific Rim. The firm is headquartered in Melbourne, Australia, and is organized into five geographic areas: Australia, Japan, Taiwan, Korea, and the United States. Supporting these areas are several centralized corporate function services (cost centers): human resources, data processing, fleet acquisition and maintenance, and telecommunications. Each responsibility center has a budget, negotiated at the beginning of the year with the vice president of finance. Funds unspent at the end of the year do not carry over to the next fiscal year. The firm is on a January-to-December fiscal year.

After reviewing the month-to-month variances, Panarude senior management became concerned about the increased spending occurring in the last three months of each fiscal year. In particular, in the first nine months of the year, expenditure accounts typically show favorable variances (actual spending is less than budget), but in the last three months, unfavorable variances are the norm. In an attempt to smooth out these spending patterns, each responsibility center is reviewed at the end of each calendar quarter and any unspent funds can be deleted from the budget for the remainder of the year. The accompanying table shows the budget and actual spending in the telecommunications department for the first quarter of this year.

PANARUDE AIRFREIGHT

Telecommunications Department: First Quarter

Budget and Actual Spending (Australian Dollars)

Monthly Cumulative Actual Cumulative Monthly Cumulative
Budget Budget Spending Spending Variance* Variance*
Jan $110,000 $110,000 $104,000 $104,000 $6,000F $6,000F
Feb 95,000 205,000 97,000 201,000 2,000U 4,000F
Mar 115,000 320,000 112,000 313,000 3,000F 7,000F
*F = Favorable; U = Unfavorable

At the end of the first quarter, telecommunications' total annual budget for this year can be reduced by $7,000, the total budget underrun in the first quarter. In addition, the remaining nine monthly budgets for telecommunications are reduced by $778 (or $7,000 Af· 9). If, at the end of the second quarter, telecommunications' budget shows an unfavorable variance of, say $8,000 (after the original budget is reduced for the first-quarter underrun), management of telecommunications is held responsible for the entire $8,000 unfavorable variance. The first-quarter underrun is not restored. If the second-quarter budget variance is also favorable, the remaining six monthly budgets are each reduced further by one-sixth of the second-quarter favorable budget variance.

Required:

a) What behavior would this budgeting scheme engender in the responsibility center managers?

b) Compare the advantages and disadvantages of the previous budget regime, where any end-of-year budget surpluses do not carry over to the next fiscal year, with the system of quarterly budget adjustments just described.