Question

(300 words please)

Since budgets affect many people in an organization, they can have significant behavioural implications. Allowing people to participate in setting their own budget targets may improve commitment those targets but create the incentive to build budgetary slack into budget estimates.

Explain three disadvantages of budgetary slack from the point of view of

1. The business unit managers who must achieve the budget

2. Corporate management

                                                                                                                 

Answer 1

Answer to the question

Disadvantages of Budgetary Slack

A budgeting slack comes with the following disadvantages:

1. Underestimating profits portrays the business as struggling

When the subordinate managers continually create easy targets, the business will be seen as underperforming in a highly competitive market. Even when the business is on track to hit new highs, the managers will use up the additional revenues left in the budget because of the budgetary slack made to the budget.

Such a practice will portray the business as struggling and may force high-performing employees to jump ship to stronger competitors. Artificially slowing down the growth may also adversely affect the company’s performance. Shareholders will start casting doubt on the company’s ability to continue generating revenues.

2. Understating revenues will affect other activities of the business

When the budget estimates for the next financial year show that the revenues are lower than what the top management projected, the company will cut the expense budget for important functions such as marketing and advertising, research and development, production, and administrative expenses. Slashing the expense budgets will affect the long-term viability of the business.

For example, reducing the expense budget for the marketing department will limit the company’s potential to get new customers and even retain existing customers, which is critical to the ongoing profitability of the business.