Organisations And Budgetary Slack: Potential Advantages And Disadvantages Of Participative Budget In Master Budget Preparation

Concept of Budgetary Slack

Discuss about the Organisations and Budgetary Slack.

Budgetary Slack refers to the deliberate way of making up the budgetary numbers in favor of the preparer, by either over estimating the budgeted expenses or underestimating the revenue.

This is more found in situations where the employees are given performance targets in numbers, their bonuses have a direct linkage with achievement of targets or Company’s policy regarding promotion (Dismissal). In this case, the base of the budget numbers will be un-realistic or on a false projection. It can be intentional or unintentional. Intentional budgetary slack also arises when there are prior experiences of not achieving either reduced expenses or increased revenue. In budgetary slack, the risk factors considered might not be genuine and will result in employees behaving unethically. In these cases, budget figures will be easy to get but will reduce quality in performance.

“The budgeting system has been assumed to affect a manager’s propensity to create budgetary slack, in the sense that this propensity can be increased or decreased by way in which the budgeting system is designed or complemented” (Amhed, 1994, p.12)

The main reason of budgetary slack is due to involving subordinate in the budget making process. But if there is a proper communication and a qualitative talk between manager and sub-ordinate, the behavioral problems with subordinates can be avoided to some extent. On the other hand, if an employee achieves the numbers, that creates more inspiration and positive view. So, the budget should not be too unrealistic or too fictional. If it is based on the proven numbers and proper design of methods to achieve the results, the budgetary slacks can be dispensed with. For an employee, who is self- motivated, takes the numbers positively and work towards the same. He takes it more challenging in case the budgets are not achieved. However, for more numbers of employees (basically at the ground level), budgets are normally a big issue to tackle. They tend to search for more options to escape from it. They may provide false data when it is sought or a false feedback about the process/systems.

Another problem is that it creates disappointment among employees. If an employee can’t achieve the budget consistently he tends to un-trust the system and gradually leaves the organization. Therefore, the budget set on these wrong data, may not serve its purpose and ultimately end up in being a tool for making/(protecting) money for self -reasons and not for business improvement. In addition, even in case of managers, the budget numbers have to be revised time to time according to change in business/market scenario. Every budget activity has to be preceded by a comparison with the actual results. A lot of time would have to be invested in explaining the top management about the variance and its reasonableness.

Participate budgeting is a activity in which the employees who are directly impacted by budget are involved in the budget making activity. It is basically a bottom line approach. Since the employees who are having hands on experience in the system are engaged in the budgeting process, the figures are normally achievable but lack a touch of strategic decision making.

Potential Advantages and Disadvantages of Participative Budget in Master Budget Preparation

“A budget can have a significant impact on human behavior. It may inspire a manager to higher level of performance. Or, it may discourage additional effort and pull down the morale of a manager” (Jerry and Donald, 2000, p. 390)

The major advantage of participative budgeting is that it will result in achievement of better results and improves motivation among employees. Since the employees know the data and conditions at the ground level, the quality of numbers will be high. Comparison of budgeted numbers with actual and reasonable check will be easy since the employees will be more familiar with the transactions rather than systems/policies. Since the targeted numbers are set by them, employees are confident and directed towards achieving it instead of being directed by the top management by their imposed budget

The disadvantage of participative budget in the master budget making process is that it consumes a lot of time since more number of employees are involved. It may lack quality since the top management’s perception about the data or conditions and their high level strategic decisions will be missing here. A main demerit of this process is the Budgetary slack.  In case the outcome or actual result of the budget is negative, it may also result in the participated departments to blame each other.

Since the relevance and use of participative budget in the master budget making process is important, a proper balancing between the related advantages and risks must be made and communicated to all the users.

Advice to VGL Ltd and Milbourn Manufacturers

A properly designed cash budget helps in ensuring cash is available at the right time and right amount. It also helps to find out if money is idle and an opportunity to save cash exists. It helps to identify the temporary cash shortages in advance.

The major strategy to meet temporary cash shortages will be arranging the overdraft from a Bank with whom Company is having tie up. In case of any surplus cash already invested, Company may tend to break the same. But, since these are normally invested in securities/fixed deposits where rate of return will be higher than that of short term borrowing it results in a cash loss. In those cases, a comparative study must be made on the opportunity cost of forgoing the interest income and the interest cost of borrowing. The best method to tackle the temporary cash shortage will be to get into the agreement with the bank to avail the overdraft facility.  Here, Company need not have further discussion with the Bank each and every time it require cash and the interest will be charged on daily basis.

“Just as judicious management of short-term surplus funds can earn extra income for the firm, careful handling of short term deficits can lead to significant savings. The treasurer’s objective in this regard should be to minimize the overall borrowing requirement consistent with the firm’s liquidity needs and to fund these at the minimum possible all in cost” (Prakash, 2008, p.543)

Strategies to Overcome Temporary Shortages of Cash

If a proper set up for arrangement of temporary cash is not in place, the Company will end up in loosing extra money in the form of high interest or penalties. They will not be able to pay the creditors in time and there by loose goodwill. The quality of production is affected if raw materials are not supplied in time and employees are not given wages.

A Company should always fix its optimum level of cash balance, which is again depending on the nature of industry or working conditions. It depends on effective cash management and borrowing capacity of the Company.

“Cash is the life blood of the business; In the day to day sense what matters for survival is the availability of adequate cash. For only cash can help the entrepreneur meet his maturing financial obligations. Failure to generate adequate cash can have serious consequences on continuing profitability and solvency of the enterprise “(Patel, 2007, p.26)

If at any time, Company fail to settle its cash obligations and it is declared legally, the Company will turn to be insolvent. Retaining employees in such situations become difficult. To conclude, as cash is the lifeblood of the business, it must be managed effectively and the shortages must be met well, howsoever small it is.

Having surplus cash in a Company denotes that the management does not know how to manage the Cash. It will create a bad impression in the investor’s mind. The investors can hardly find out the reason for investing their money in the Company when there is not much changes in the Cash balance between two consecutive accounting periods. The main issue with having surplus cash is the opportunity cost connected with the forego of income from investment. A Management holding too much cash may tend to be more careless about its management. There will not be much pressure of performance.

“The benefit of investment is that the cash is not lying idle and the firm earns a specific return. But the problem is that making of such investment or disinvestment in order to get the cash back involves a transaction cost or conversion cost. If on the other hand, no such investment is made, such conversion cost does not arise, but there exists an opportunity cost in terms of interest foregone” (Sharan, 2012, p173)

Some organizations consider having surplus cash as symbol of strength, but having too much cash not put in use actually hurts.

Preparation and analysis of environmental cost report

Strategy for prioritizing spending on environmental cost categories to reduce negative outcomes

For implementing an effective strategy on the spending on environmental costs, management needs a specific idea and information about the nature of Company’s products and operations. The definition and classification of environmental costs within a Company is depending on how the information is intended to be used. Since the environmental laws and procedures are ever- changing and the environmental management is critical, a pro-active management should recognize the requirement for integrating the environmental strategies into the main decision making. The four major categories of Environmental Costs are (a) Prevention Costs (b) Detection Costs (c) Internal Failure Costs (d) External Failure Costs. The intensity and sensitivity of these costs are different from each other. Out of the four, external failure costs are more challenging and sensitive.

“Organizations tend to define environment related costs differently depending on the intended use of the cost information, the organization’s view of what is ‘environmental’, the organizations’ economic and environmental goals and other reasons” (Schaltegger, Bennett, Burrit and Jasch, 2008, p.329)

Many established organizations especially in Industrial sector, have already understood the importance of Environmental cost management and is enjoying the benefits out of it. Non-Compliance of environmental laws could lead to huge fines and penalties and loss of goodwill. The society expects the Companies and products should be environmental friendly. Therefore, a best method of environmental cost management which define the proposition in which these costs and spent and analyzed should be implemented.

A proper prioritization of spending on environmental costs is needed to ensure that the best is made out of it. For example, spending effectively on prevention and detection costs will bring a big reduction on the failure costs. In case of Milbourn Manufacturers, the cost spent on “Testing for contamination” is $ 28,000 (Detection Costs) and they end up in paying $ 260,000 on “Cleaning up the contaminated soil” (External Failure Costs). If a proper study is made before spending on environmental costs, the investment on testing for contamination would be more and the result will bring out the best possible method of production to avoid failure and end up in spending on the cleaning cost lesser.

Generally, the environmental costs are reported along with general overheads. A separate reporting of these costs and a further analysis of the same with respect to the total income/total costs or allocation of the same into cost objects will help to identify the crucial relationships between environmental costs and related products/process. A comparison of the costs should be made with that of previous periods, other divisions of the Company or other organizations in the industry. While preparing the specific report on environmental costs, attention must be also given to qualitative /non-monetary measures which portray the Company as more environmental friendly.

References

Amhed, R. (1994) Organisations and budgetary slack, London: Quoram books.

Apte, P. (2008) International financial management, New Delhi: Tata McGraw-Hill Publishing Company Limited.

Jerry, J. Paul, D. Donald, E. (2000) Managerial Accounting Tools for business Decision making, USA: John Viley & Sons Inc.

Patel, V.G. (2007) When the Going Gets tough strategic responses to Business crisis, New delhi: Tata McGraw-Hill Publishing Company Limited.

Schalteggar, S. Bennet, M. Burrit, R. L. and Jasch, C. (2008) Environmental Management Accounting for a Cleaner Production, UK: Springer Science.

Sharan, V. (2012), Fundamentals of Financial Management, India: Dorling Kindersley (India) Pvt Ltd