Negative Effects of Budgetary Slack

Question:

Discuss About The Values Behavioural Research In Accounting?

Budgetary slack is defined as the managerial practice of deliberately overstating costs and underestimating revenues in order to make budget goals easily attainable and present a profitable image of the organisation (Whittington & Delaney, 2011). It provides a cushion-like effect in the organisations budget so as to avoid or mitigate unfavourable results. Various scholars have presented an array of opinions on the concept of budgetary slack. It can be described as insurance for uncertainties, a consequence of pressure on the budgetary system, a subsequent reaction to a company’s remuneration policies or an ethical issue (Frezatti, et al., 2013). Additionally, some managers rely on it as a risk management tool (Demartini, 2014). The following report has been commissioned by the senior management at Nestle Australia to discuss the concept of budgetary slack and its consequences with particular regard to their bonus program. Having analysed the company’s budgetary process and the issues arising from the current approach the report will provide relevant recommendations to mitigate budgetary slack concerns.

Various scholars have provided a plethora of arguments as to the effects, both negative and positive, of budgetary slack on an organisation. The following section aims to highlight some of the negative effects of employing budgetary slack as a management tool. One of the consequences to consider is that budgetary slack leads to an inflation of costs and reduction of profits for the organisation (Milad, 2010). This is because the information provided is used to make decisions and allocate resources as such, the company may end up inflating its actual costs based on the information provided in the budgets. As outlined in the case study, the final budget is created after negotiations with the managers and the CFO; the managers’ budgets are used to estimate future budgets thus creating a cycle of inflation.

Budgetary slack also contributes to inefficiencies in resource allocation (Kopel & Riegler, 2014). As aforementioned, budgetary slack is an overestimation or underestimation of costs and revenues respectively; this deliberate misinformation may lead to bias in resource allocation. Most of the time, top management is unaware and uninvolved in the creation of slack, therefore they rely on the information provided by branch managers in their budgets to allocate resources. As the information is inaccurate, the resources allocated to meet company objectives will be based on misinformation thus leading to inefficiencies. This is particularly detrimental to large organisations like Nestle as the resources would have otherwise been redirected to more suitable ventures.

Effects on Resource Allocation

Additionally, the inefficiencies in resource allocation present a negative impact on the organisation’s performance and profitability ( binti Abu Bakar, et al., 2014). Where employee rewards are driven by an achievement of budgetary goals then slack is likely to exist. Incorporating slack into the budgetary process for an extended period of time ultimately affects the overall performance of the organisation which can be determined by a comparison between the organisation’s competitiveness against its industry rivals (Bragg, 2013). Therefore, in the long run, budgetary slack presents a negative consequence of the organisation’s profitability and competitive advantage.

Further, due to the manipulation of budgets, budgetary slack affects the reliability of information as it provides an unrealistic view of company operations ( binti Abu Bakar, et al., 2014). This, in turn, affects the effectiveness of the organisations planning systems as upper management may undertake unnecessary steps to decrease expenses and boost sales. Additionally, management is unable to highlight defects in its systems as the information presented paints a different picture of what is on the ground. Additionally, the objectivity in the evaluation of employees is limited as it is based on manipulated information and as such the perceptions created are inaccurate.

Budgetary slack may also affect contractual principles and subsequently contractual relationships due to the behavioural change attributable to participatory budgeting (Raghunandan, et al., 2012). Driven by promotions and bonuses as an incentive to achieve budget goals, employees are likely to adopt a self-interests approach in the exercise of their duties thus creating an opportunity for budgetary slack. As agents, employee loyalties should lie with the company objectives, however, budgetary slack may lead to a compromise in their contractual obligations as they aim to satisfy their own interests.

The creation of budgetary slack, particularly in an organisation whose pay scheme is based on performance with regard to bonuses other incentives is considered unethical (Chandra, 2010). Budgetary slack is particularly common where the organisation adopts a participative budgeting approach; that is where each level of management is invited to contribute to the budgeting process (Weygandt, et al., 2010). As aforementioned, budgetary slack creates an unrealistic image of the company’s position. As such reliance on this information leads to the setting of unrealistic standards and as such managers, in the long run, are under more pressure to perform so as to earn their bonuses or other incentives. This drives them to incorporate more slack in the budget. These behavioural adaptations to pressure which are driven by deceit create an ethical challenge for the business.

Effect on Reliability of Information and Contractual Relationships

In Nestlé’s case, the organisation clearly adopts a participative budgeting system as managers engage the CFO in analysing the quarterly budget and it is assumed these negotiations contribute to the overall annual budget. Further, the organisation has adopted a bonus program which therefore places pressure on managers to meet budgetary goals. Both these characteristics of Nestlé’s budgeting process present suitable grounds for managers to create budgetary slack. As the slack is driven by personal interest to attain budgetary goals and receive the stipulated incentives it is therefore unethical and compromises the obligations of branch managers to the organisation.

As previously mentioned, the Nestle has adopted a bonus program for rewarding branch managers; the organisation’s budgets are used to evaluate performance. Well-performing managers are rewarded with bonuses, salary increases or promotions. Research shows that where budgeting is used as a motivational instrument in agency situation, budgetary slack is likely to exist and increase (Liessem, et al., 2015). It has been attested that budgets formulated under a slack-inducing pay scheme; where employees are motivated by financial incentives, create high levels of budgetary slack. Financial incentives, therefore, play a significant role in setting out the moral frame of the organisations budgeting process. Personal values and interest further influence how they respond to the frame set out above (Hobson, et al., 2011).

It is evident, from the literature set out above that, financial incentives; by way of bonuses, salary increases or promotions, play a significant role in shaping the behavioural patterns of employees. This is because they create pressure to perform or please the principal or authority in order to gain financially. As such, decisions of the agents or in this case branch managers, are likely to be driven by the desire to gain bonuses promotions. This creates room for dishonesty and deception. Managers will, therefore, adopt tactics such as slack so as to create the perception that budgetary goals have been achieved. In the long run, the bonus program only serves to promote and increase budgetary slack as budgets in the Nestle Company are used as a motivational instrument thus affecting employee behaviour.

Conclusion

In conclusion, the report set out to highlight the concept of budgetary slack and its consequences for the operations of Nestle Australia. Further, the report aimed to highlight the ethics of branch managers’ behaviour and how the bonus program would influence budgetary slack. From the discourse, budgetary slack has been defined as the overestimation of costs and downplay of revenues by managers. Although utilized far and wide as a management tool, researchers have identified that budgetary slack can be unethical where deliberate dishonesty for personal gain is employed. The report further outlined that cost inflation, inefficient resource allocation, unreliability of information and compromised contractual relationships are some of the consequences Nestle is likely to face from the existence of budgetary slack in its processes. The branch managers’ conduct to create budgetary slack in order to gain bonuses is unethical as it is driven by dishonesty and is a compromise of their obligations as agents of the company. Additionally, the bonus program serves as a driver for the creation of budgetary slack as it influences employee behaviours and promotes personal interest.

Having analysed Nestlé’s position as discussed above, the study proposes the following solutions to combat or mitigate the issue:

1. Budgetary slack can be reduced through proper training of managers as well as employees on the value of realistic and achievable budgets.
2. Additionally, the company could consider a different motivational tool; that is, rely on other aspects of employee obligations for performance evaluation as over-reliance on budgets has detrimental effects on employee behaviour thus contributing to the creation of budgetary slack.
3. The organisation could also adopt truth-inducing incentives; these cultivate a culture of honesty and a respect for the value of budgets thus reducing the creating of slack. Creating incentives for accurate communication of information goes a long way in maximising organisational performance.

References

binti Abu Bakar, N. R. et al., 2014. Impact of Organisational Factors on Budgetary Slack. s.l., Kolej Universiti Islam Antarabangsa Selangor.

Bragg, S., 2013. Budgetary Slack. [Online]
Available at: https://www.accountingtools.com/articles/what-is-budgetary-slack.html
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Chandra, D. S., 2010. Management Control Systems: Principles and Practices. s.l.:PHI Learning Pvt. Ltd.

Demartini, C., 2014. Performance Management Systems: Design, Diagnosis and Use. Italy: Physica-Verlag.

Frezatti, F., Beck, F. & da Silva, J. O., 2013. Perceptions about the Creation of Budgetary Slack in a Participatory Budget Process. Journal of Education and Research in Accounting, 7(4), pp. 322-341.

Hobson, J. L., Mellon, M. J. & Stevens, D. E., 2011. Determinants of Moral Judgements Regarding Budgetary Slack: An Experimental Examination of Pay Scheme and Personal Values. Behavioural Research in Accounting, 23(1), pp. 87-107.

Kopel, M. & Riegler, C., 2014. Slack and Participative Budgeting-Always an evil? s.l.: University of Graz.

Liessem, T., Schedlinsky, I., Schwering, A. & Sommer, F., 2015. Budgetary slack under budget-based incentive schemes-the behavioural impact of social preferences, organisational justice and moral disengagement. Journal of Management Control, 26(1), pp. 81-94.

Milad, A. I., 2010. Business Management Handbook. Indiana: Author House.

Raghunandan, M., Ramgulam, N. & Raghunandan-Mohammed, K., 2012. Examining the Behavioural Aspects of Budgeting with Particular Emphasis on Public Sector/Service Budgets. International Journal of Bussiness and Social Science, 3(14), pp. 110-117.

Weygandt, J. J., Kimmel, P. D. & Kieso, D. E., 2010. Managerial Accounting: Tools for Business Decision Making. 5th ed. s.l.:John Wiley & Sons.

Whittington, R. O. & Delaney, P. R., 2011. Willey CPA Exam Review. 38th ed. New Jersey: John Wi