Question

Tanya Williams is the new accounts manager at Southpac Bank. She has just been asked to estimate how many new bank accounts she will generate during the next year. The Australian economy has been growing and the bank has experienced a 10 percent increase in the number of bank accounts over each of the past five years. In the year just ended the bank had 10000 accounts.

The new accounts manager is paid a salary plus a bonus of $50 for every new account she generates above the budgeted amount. Thus, if the annual budget calls for 500 new accounts and 540 new accounts are achieved, Williams’ bonus will be $2 000 (40 × $50). Williams believes that the economy will continue to grow at the same rate next year as it has in recent years. She has decided to submit a budgetary projection of 700 new accounts for the coming year.

Required:

1)Your consulting firm has been hired by the managing director of the bank to make recommendations for improving its operations. Define and explain the negative consequences of budgetary slack.

2)Discuss how the bonus program may encourage budgetary slack.

3)How might the bank reduce the incentive to create budgetary slack?

Answer 1

1) Budgetary slack is the difference between the revenue or cost that a person provides and a realistic estimate of the revenue or cost. The practice of creating budgetary slack is called padding the budget.

The primary negative consequence of slack is that it undermines the credibility and usefulness of the budget as a planning and control tool. When a budget includes slack, the amounts in the budget no longer portray a realistic view of future operations.

2) The bank’s bonus system for the new accounts manager may encourage budgetary slack. Since the manager’s bonus is determined by the number of new accounts generated over the budgeted number, there is an incentive for the manager to understate her projection of the number of new accounts.

There is evidence of this in the description of the new account manager’s behavior. A10 per cent increase over the bank’s current 10,000 accounts would mean 1000 new accounts in next year. Yet the new account manager’s projection is only 700 new accounts.

This will make it more likely that the actual number of new accounts will exceed the budgeted number, resulting in the manager obtaining a bonus for her apparent ‘good performance'.

3) The bank could consider some alternative measures for balancing the dysfunctional aspects encouraged by the current system.

A bonus could be rewarded for any increase in new accounts above the 10 per cent increase that has occurred over the past few years. Perhaps for every 1 per cent increase over the 10 per cent target, a bonus could be paid.

New account volumes should be calculated on a net basis; i.e. accounts that are closed during the year could be deducted from the number of new accounts opened. This could encourage the manager to maintain customer satisfaction.

Bonuses could also be based on a range of performance targets, including the results of customer satisfaction surveys and reductions in customer complaints.