Question

Budgetary Slack with Ethical Considerations

Norton Company, a manufacturer of infant furniture and carriages, is in the initial stages of preparing

the annual budget for next year. Scott Ford recently joined Norton’s accounting staff and is interested to

learn as much as possible about the company’s budgeting process. During a recent lunch with Marge Atkins, sales manager, and Pete Granger, production manager, Ford initiated the following conversation:

Ford: Since I’m new around here and am going to be involved with the preparation of the annual budget,

I’d be interested to learn how the two of you estimate sales and production numbers.

Atkins: We start out very methodically by looking at recent history, discussing what we know about

current accounts, potential customers, and the general state of consumer spending. Then we add that

usual dose of intuition to come up with the best forecast we can.

Granger: I usually take the sales projections as the basis for my projections. Of course, we have to make

an estimate of what this year’s closing inventories will be, which is sometimes difficult.

Ford: Why does that present a problem? There must have been an estimate of closing inventories in the

budget for the current year.

Granger: Those numbers aren’t always reliable since Marge makes some adjustments to the sales num-

bers before passing them on to me.

Ford: What kind of adjustments?

Atkins: Well, we don’t want to fall short of the sales projections, so we generally give ourselves a little

breathing room by lowering the initial sales projection anywhere from 5 to 10 percent.

Granger: So, you can see why this year’s budget is not a very reliable starting point. We always have

to adjust the projected production rates as the year progresses; of course, this changes the ending

inventory estimates. By the way, we make similar adjustments to expenses by adding at least 10

percent to the estimates; I think everyone around here does the same thing.

Ford: Since I’m new around here and am going to be involved with the preparation of the annual budget, I’d be interested to learn how the two of you estimate sales and production numbers.

Atkins: We start out very methodically by looking at recent history, discussing what we know about

current accounts, potential customers, and the general state of consumer spending. Then we add that

usual dose of intuition to come up with the best forecast we can.

Granger: I usually take the sales projections as the basis for my projections. Of course, we have to make

an estimate of what this year’s closing inventories will be, which is sometimes difficult.

Ford: Why does that present a problem? There must have been an estimate of closing inventories in the

budget for the current year.

Granger: Those numbers aren’t always reliable since Marge makes some adjustments to the sales numbers before passing them on to me.

Ford: What kind of adjustments?

Atkins: Well, we don’t want to fall short of the sales projections, so we generally give ourselves a little

breathing room by lowering the initial sales projection anywhere from 5 to 10 percent.

Granger: So, you can see why this year’s budget is not a very reliable starting point. We always have

to adjust the projected production rates as the year progresses; of course, this changes the ending

inventory estimates. By the way, we make similar adjustments to expenses by adding at least 10

percent to the estimates; I think everyone around here does the same thing.

Questions:

1. Atkins and Granger have described the use of budgetary slack. Explain why Atkins and Granger behave in this manner. Describe the benefits they expect to receive from the use of budgetary slack. Explain how the use of budgetary slack can adversely Atkins and Granger.
2. As a management accountant, Scott believes that the behavior described by Atkins and Granger could be unethical --and that he might have an obligation not to support this behavior. Explain why the use of budgetary slack could be unethical.  
3. Discuss ways in which organizations can minimize the opportunity of budgetary slack to intrude on the budgetary process.

Answer 1

1.     a.     The reasons that Marge Atkins and Pete Granger use budgetary slack include the following:

·They are hedging against the unexpected, thereby reducing uncertainty and risk.

·The use of budgetary slack allows employees to exceed expectations and/or show consistent performance. This is particularly important when performance is evaluated on the basis of actual results versus budget.

·Employees are able to blend personal and organizational goals through the use of budgetary slack as good performance generally leads to higher salaries, promotions, and bonuses.

        b.     The use of budgetary slack can adversely affect Marge and Pete by:

·Limiting the usefulness of the budget to motivate their employees to top performance.

·Affecting their ability to identify trouble spots and take appropriate corrective actions.

·Reducing their credibility in the eyes of management.

·Also, the use of budgetary slack may affect management decision making, as the budgets will show lower contribution margins (lower sales, higher expenses). Decisions regarding the profitability of product line, staffing levels, incentives, etc., could have an adverse effect on Marge’s and Pete’s departments.

2.     The use of budgetary slack, particularly if it has a detrimental effect on the company, may be unethical. In assessing the situation, the specific provisions of the “Standards of Ethical Conduct for Management Accountants” that should be considered are:

        Competence: Provide decision support information and recommendations that are accurate, clear, concise, and timely.

  Integrity: Refrain from engaging in any conduct that would prejudice carrying out duties ethically.

  

  Credibility: Information should be fairly and objectively communicated. All relevant information should be disclosed.