Ethics and Budgeting

It is important for you to understand that a budget is a canon, or standard, by which a company will assess forecasts compared to actual results. Budgets are often engaged as a tool for gauging performance of managers, divisions, segments, or affiliated departments.

It is equally important to recognize that only the use of valid forecasts will yield the intended results. If results are to be credible, budget manipulation must be eliminated. The term budgetary slack has been used to describe the process of deliberately skewing net income downward so as to appear to perform better against standards. Therefore, it is important that you be able to recognize these efforts and to implement the highest standards of budgetary conduct.

Because the motivation for budgetary slack may increase directly in proportion with the size of a company, the Unit 3 Discussion will help you explore the likelihood that overall organizational goals may suffer due to short-term goal setting within smaller units of the company.

Read the following Scenario

The Children's Shoe Company has 100 franchised locations and 6 regional offices. Each region is managed by a director who reports to the VP of Operations. In addition to the vice president of operations, executive management includes the chief financial officer (CFO), the vice president of marketing, and the vice president of human resources. All executive personnel work at the corporate headquarters in NY. Each director maintains a regional office, complete with an administrative staff.

Shortly after taking over the company, the new management revised the budgeting process. The new budget process is a top-down process. Because the new budget process affects a director's compensation, directors have a vested interest in budget development. To start the budget cycle, regional directors are given executive goals for the subsequent year's budget. Those goals include projected growth in new stores locations and improved revenues, limited salary increases, and allocated corporate expenses. Directors prepare three budgets - one for franchised locations, one for corporate locations, and one for administrative costs associated with the regional offices. The regional budgets are consolidated into the corporate budget.

The director of region four follows a routine method for budget preparation. He delivered the corporate budget goals to his regional accountant to prepare the first draft of the budget. After the director of region four reviewed the first draft, he was not pleased. In the director's opinion, budgeted net income was too high for the region to achieve. The regional director asked the accountant to make adjustments.

Corporate goals included a general price level increase of 2-4 percent. The range was designed for flexibility to allow higher cost-of-living areas such as Boston and New York to budget higher levels of cost increases than lower cost-of-living areas. But even though region four is located in the lowest cost-of-living area for the company, the director told the accountant to budget the maximum increase of 4 percent. The director was confident that because the increase was within the stated goals, the corporate office would not notice.

Even though the director knew that it was not a reasonable goal, he also told the accountant that region four would open eight (8) new stores during the coming year. Therefore, the budget should reflect accelerated start-up costs to consider the expansion. Based on historical precedent, the region could realistically expect to only open four (4) or five (5) new locations.

The director of region four has a reputation for retaliating against employees who choose to ignore his demands. Therefore, the accountant made the changes without hesitation. The result was a significant reduction in region (4) four's budgeted net income.

The accountant is a Certified Management Accountant (CMA) and is responsible for all of his family income. Therefore, losing the job in region four would be devastating.

Checklist:

(a) Why do you think that the director of region four (4) would care about the level of budgeted net income?

(b) What do you think the new owner's reaction would be if they learned of the director's actions?

Post to the Discussion per your Syllabus guidelines.