Budgetary slack refers to the deliberate overestimation of expenses or underestimation of revenues by managers in anticipation of future cash flow so as to make the targets easier to achieve especially in situations where performance appraisals or bonuses are based on the set-out targets (Dyckman, et al). Sometimes managers practice this built-in budgetary slack to achieve performance targets so that they are viewed favorably by the outside stakeholders like the investors (Warren, 2019). Let’s look at the scenarios Bailey has proposed;
Use the top quartile for all wages and salary categories
By using the top quartile for wage and salaries, Bailey will be overestimating the possible expenditure the company can incur on wages in the upcoming financial year thereby creating a budget slack. For instance if the top quartile wage bill was $1.5 million, and the lowest quartile was said, $750, 000 for wage and salary expenses, by using the top quartile Bailey ensures that the department will meet their target since it is likely that the wages and salary bill may not hit the top quartile easily. If they used the lowest of $750,000, the wages may easily surpass this mark. Using the top quartile ensures the target is easier to achieve hence creating a budget slack.
Delegate your assignment to our experts and they will do the rest.
Selecting the optimistic values for estimated production ranges for the coming year
Bailey proposes using the optimistic values for estimated production ranges provided by the marketing department for the coming year as a base for performance evaluation. A range refers to the area of variations between set out upper and lower limits. Using this estimated production range increases the chance of the department meeting their target thereby creating a budget slack. For example, if the marketing department gives an estimated range of production of between 2 million to 3.5 million units, the following year's production units may fall within this range even if it is lower and closer to the lowest limit thereby making it easier to achieve.
Use the average of the three months in the current year with the poorest production efficiency as a benchmark for success for the coming year
By using the average of the three months with the poorest production efficiency, Bailey will be setting the benchmark for success for the next period at a low scale which will be much easier to achieve, thereby creating a budget slack. If for example in a case where the three months' with the poorest production averaged efficiency of 500,000 units while the three months with the highest production averaged efficiency of 1.5 million units, taking the highest performing months as a benchmark makes the target much harder to achieve as compared to the poorest months’ average. This will create a budget slack.
Base equipment charges (depreciation) on replacement values furnished by the purchasing department
Replacement value refers to the amount an entity would have to pay to replace an asset at the present time according to its worth at the moment ( Byström, 2011) . Basing depreciation on replacement value may or may not cause budgetary slack depending on the prevailing market conditions. Market prices for equipment and other items fluctuate according to prevailing economic tides. If for instance, the replacement value of the equipment will be higher than the historical cost in the coming year, then the depreciation cost will be high. If however, the replacement value of the equipment will be lower than the actual cost in the following year, then the depreciation cost will be lower thereby causing a budget slack.
Base other fixed costs on current costs plus an inflation rate estimated for next year
Basing fixed cost on the current rate and adjusting for inflation will overestimate the fixed cost amount. Inflation estimations are arbitrary and may not reflect the economic conditions when the time reaches. If for instance, the fixed costs are $2 million and adjusted inflation increases the costs to $2.5 million, the fixed costs will be higher for the next year thereby creating room for a budget slack by overestimating the cost.
Use the average of the ten newly hired employees’ performance as a basis of labor efficiency for the coming year
Newly hired employees normally take time to adapt and undergo some training in order to get up to speed with the new work environment and to perform to the required standards. they normally undergo a period of learning which makes them prone to mistakes and are slow and low on output. Basing the performance efficiency of the newly hired employees as a benchmark for the coming year for everybody will set the goal low and easy to achieve thereby creating a budget slack.
B). Static budget vs. built-in budget slack
A static budget is a budget that does not change throughout the year even as volume changes (Boyd, 2013). If for example, the production cost in a static budget is $2 million dollars for the year, this figure will remain so during the entire year regardless of the fluctuations in the level of production. The managers can justify the use of built-in budget slack in a case of the static budget because such a budget does not give room for flexibility yet the production levels can fluctuate due to certain external factors which the managers may not be able to control. By having a built-in budget slack in the static budget, this ensures that the managers' targets are lowered considerably and they are cushioned against such adverse fluctuations.
C). Recommendations on ways to improve the budget situation
Some of the ways that Bailey can use to improve the budget process include the following:
Keep budgeting and forecasting flexible; when the process is too static it may affect the overall performance. The process needs o to allow room for adjustments to accommodate uncertainties.
Implement rolling forecast and budgets; rolling forecasts are based in present results and allow for continuous improvements while at the same time ensures the accuracy of projections. Bailey can vouch for budgets and forecasts to be based on quarterly results and the projections are adjusted accordingly (Carlitz, 2013).
Involve the entire team; Bailey should ensure that all the departments and stakeholders are involved in the budgeting process so that everyone's input is considered. This ensures that all stakeholders are working towards achieving a common company objective.
References
Carlitz, R. (2013). Improving Transparency and Accountability in the Budget Process: An Assessment of Recent Initiatives. Development Policy Review , 31 , s49-s67. doi: 10.1111/dpr.12019
WARREN, C. (2019). FINANCIAL & MANAGERIAL ACCOUNTING . [Place of publication not identified]: CENGAGE LEARNING.
Byström, H. (2011). An Alternative Way of Estimating Asset Values and Asset Value Correlations. The Journal Of Fixed Income , 110831044120005. doi: 10.3905/jfi.2011.2011.1.010
Boyd, K. (2013). Cost accounting for dummies . Hoboken, N.J.: Wiley.
Dyckman, T., Hanlon, M., Magee, R., Pfeiffer, G., Hartgraves, A., & Morse, W. et al. Financial & managerial accounting for MBAs .
