ACCT 209 Week 5 Discussion Board Forum 2 Example

Discussion Board Forum 2: Budgets, Planning and Performance

ACCT 209 Survey of Accounting and Finance, Discussion Board Forum 2

Thread by [Student Name]

The company example and the classmates are composites; the peer-reviewed sources cited are real.

Imagine a regional sales manager whose bonus depends on beating the annual sales budget. In the budget meeting, she argues that the market is weak and proposes a modest target, even though she expects her team to do better. If the year goes well, she may also delay some December orders into January so next year's target is easier to reach. She is not breaking any rule; she is responding rationally to how she is paid. Her counterparts in production and purchasing have the same incentive, so the company's whole plan ends up built on cautious numbers that nobody fully believes.

This cushion is called budgetary slack: the deliberate padding of a budget, through low sales forecasts or generous cost estimates, so its targets are easy to beat. Jensen (2003) argued that tying bonuses to budget targets effectively pays people to lie, because it rewards managers for setting low targets and for managing the timing of results rather than for creating value. Under such systems, he observed, managers have reasons to hide what they know about their unit's real potential, which undermines the very information the budget is supposed to gather. The cost is not only a padded target but poorer decisions, since leaders plan hiring, purchasing and investment around forecasts that understate what the organization can actually do.

Still, budgets are far from obsolete. Libby and Lindsay (2010) surveyed North American companies and found that most continued to rely on budgets for planning, coordination and control and did not intend to abandon them, although many were changing how budgets were used, for example by updating them more often or relying less on fixed targets for evaluation. Budgets help managers coordinate purchasing with sales, plan cash needs and spot problems early. The budget is a good plan and a poor paycheck: the trouble starts when the same number has to serve as both.

The practical answer is to separate the two roles. A company can use the budget to plan and coordinate, while rewarding managers on actual performance measured against prior years, competitors or market conditions rather than against a number the manager helped set. When the bonus no longer depends on a low target, the manager has less reason to sandbag, and the budget becomes a more honest forecast. Managers outside accounting should understand this dynamic, because they are the ones who set, negotiate and live by these numbers. A department head who knows why slack appears can build an honest budget and ask better questions about others.

Reply to Megan

Megan, you suggested that letting managers help set their own budgets would build commitment and reduce resistance, and that instinct has real support in the research literature. Research suggests participation can help, but its effect on slack depends on how the budget is used. Shields and Shields (1998) reviewed studies of participative budgeting and found that firms tend to use participation when managers have information that senior leaders lack, such as knowledge of local markets or operations, because participation brings that information into the plan. In a study of managers within a large company, Merchant (1985) found that participation was associated with less propensity to create slack, but that strong emphasis on meeting the budget pushed in the opposite direction. Taken together, the two studies suggest that participation works best when the budget is treated as a shared plan rather than as the basis for a bonus. If participation simply invites managers to negotiate easier targets, it may increase slack instead of reducing it. One practical step is to ask managers to explain the assumptions behind their numbers, such as expected prices and customer counts, so that leaders can test the reasoning rather than simply accept or cut the total.

Reply to Tyler

Tyler, your thoughtful idea of replacing the annual budget with a rolling forecast that is updated each quarter is a common response to the problems Jensen described. Hansen et al. (2003) reviewed practitioner critiques of traditional budgeting, including proposals to move away from fixed annual targets, and they distinguished the planning role of budgets from their role in evaluating performance, arguing that the two roles create the tension behind gaming, since a single number cannot be both an honest forecast and a stretch target. Ekholm and Wallin (2000) surveyed Finnish companies and found that, despite widespread criticism, few had abandoned the annual budget, and many combined it with other tools such as rolling forecasts and balanced scorecards. That suggests your proposal could work best as an addition to the budget rather than a full replacement for it: a rolling forecast keeps plans current as conditions change, while a simpler annual budget still supports cash planning and coordination. The key, again, is not to tie bonuses to the forecast, or managers will learn to shade it the same way. A company that adopts rolling forecasts should also reward forecast accuracy over time, so that managers gain from telling the truth about what they expect rather than from setting numbers they know they can beat.

References

Ekholm, B.-G., & Wallin, J. (2000). Is the annual budget really dead? European Accounting Review, 9(4), 519-539. https://doi.org/10.1080/09638180020024007

Hansen, S. C., Otley, D. T., & Van der Stede, W. A. (2003). Practice developments in budgeting: An overview and research perspective. Journal of Management Accounting Research, 15(1), 95-116. https://doi.org/10.2308/jmar.2003.15.1.95

Jensen, M. C. (2003). Paying people to lie: The truth about the budgeting process. European Financial Management, 9(3), 379-406. https://doi.org/10.1111/1468-036X.00226

Libby, T., & Lindsay, R. M. (2010). Beyond budgeting or budgeting reconsidered? A survey of North-American budgeting practice. Management Accounting Research, 21(1), 56-75. https://doi.org/10.1016/j.mar.2009.10.003

Merchant, K. A. (1985). Budgeting and the propensity to create budgetary slack. Accounting, Organizations and Society, 10(2), 201-210. https://doi.org/10.1016/0361-3682(85)90016-9

Shields, J. F., & Shields, M. D. (1998). Antecedents of participative budgeting. Accounting, Organizations and Society, 23(1), 49-76. https://doi.org/10.1016/S0361-3682(97)00014-7