Question

Is budgetary slack a desirable feature? Can it be prevented? Why or why not?

Answer 1

Q.1 Is budgetary slack a desirable feature? Can it be prevented? Why or why not?

Answer : Budgetary slack is a cushion created in a budget by management to increase the chances of the actual performance beating the budget. Budgetary slack can take one of two forms: an underestimate in the budget of the amount of income or revenue that will come in over a given amount of time, or an overestimate of the expenses that are to be paid out over the same time period.

For example, if a senior manager's bonus is tied to meeting certain budget targets, then adjusting the budget for a more favorable outcome would be incentivized. Managers putting a budget together could low-ball revenue projections, pump up estimated expense items, or both, to produce numbers that will not be hard to beat for the year.

However, sometimes it is genuinely the case that management is unsure of the numbers. Economic forecasts are fuzzy, industry changes are rapid, or a new slate of products is about to be launched. In these instances, the future performance of the company is uncertain and managers prefer to be conservative. Management could be exonerated in such cases for publishing a lazy-looking budget. The best way to avoid budgetary slack is to install a management team with integrity.

Budgetary slack Can be prevented : Budgetary slack is a cushion created in a budget by management to increase the chances of the actual performance beating the budget.

Following are the ways to Prevent Budgetary Slack:  

1. Evaluation System

Organizations can reduce budgetary slack when they stop using budget as a negative evaluative tool. For instance, instead of criticizing subordinates every time a budgeted target is not achieved, if the subordinates are allowed some discretion to exceed costs when unavoidable, there will be a lesser tendency to create budgetary slack.

2. Truth-Inducing Pay Scheme

A problem occurs in participative budgeting when a subordinate has private information about factors that influence his or her performance and the pay scheme is budget or standard-based. The employee has an advantage to keep away this information from superiors so that a relatively easy standard is set, thereby creating slack. To eliminate this problem, research proposes a truth-inducing pay scheme to motivate subordinates to accurately communicate private information and maximize performance, thereby reducing budgetary slack.

3. Participative Budget

Participative Budget is an ideal budgetary process. Most companies deviate from this ideal budgetary process. Typically top managers initiate the budget process by issuing broad guidelines in terms of overall target profits orsales. Lower level managers are desired to prepare budgets that meet those targets. The difficulty is that the target set by top managers may be unrealistically high or may allow too much slack. If the budgets are too high and employees know they are unrealistic, motivation will suffer. If the targets allow too much slack, waste will occur. And unfortunately top management is often not in a position to know whether the targets they have set are appropriate.

Admittedly, however, a pure self imposed budgeting system is not without limitations. It may lack sufficient strategic direction and lower level managers may be tempted to build into their budgets a great deal of budgetary slack. Nevertheless, because of the motivational advantages of self imposed budgets, top managers should be cautious about setting inflexible budgets.

4. Zero-Based Budgeting

The problem of budgetary slack is particularly acute when the prior year’s budget is used as the starting point for preparing the current budget. This is called “incremental budgeting”. It is presumed that established levels from previous budgets are an acceptable baseline, and changes are made based on new information. This usually means that budgeted amounts are incrementally increased. The alternative to incremental budgeting is called “zero-based budgeting.”

With zero-based budgeting, each expenditure taxes and fees. This gives rise to considerable frustration in trying to control spending. Some governmental leaders push for zero-based budgeting concepts in an attempt to filter necessary services from those that simply evolve under the incremental budgeting process.