Budget Slack Analysis: Exploring Causes, Impacts, and Best Practices

This report provides a comprehensive analysis of budget slack, a deliberate overestimation of expenditures or underestimation of revenues in budgeting. It explores the reasons behind budget slack, including managerial self-interest and uncertainty, and its effects on financial statements and organizational performance. The report examines the effects of budget slack on financial statements, leading to misleading financial projections. It further discusses the impacts of budget slack on organizational performance, including the use of the budget for performance evaluation. Strategies for avoiding budget slack, such as zero-based budgeting, participative budgeting, truth-inducing pay schemes, and evaluation systems, are presented. The report includes examples of proper versus slack-created budgets and discusses both short-term and long-term effects, referencing relevant literature.

Running head: QUESTIONS 0
BUDGET SLACK
FEBRUARY 20, 2020
STUDENT DETAILS:

QUESTIONS 1
Contents
Introduction of Budget slack and its origin..................................................................................................2
Reason of creation of budget slack..............................................................................................................2
Effects of budget slack in the financial statements of entity........................................................................2
Effects of budget slack on the organisational performance of entity...........................................................2
Avoidance of budget slack..........................................................................................................................3
Proper methods and tools to avoid budget slack..........................................................................................3
Solutions of budget slack.............................................................................................................................4
Examples of the proper budgeting vs. slack created budget........................................................................4
Long-term effect and short-term effect of budget slack...............................................................................4
References...................................................................................................................................................5

QUESTIONS 2
Introduction of Budget slack and its origin
The budget slack is considered as the deliberate over estimation of budgeted expenditures
or under estimation of budgeted revenues. The budget slack permits a managers best opportunity
of "creating the numbers," that is specifically significant for them if performance appraisal as
well as bonus is tied to the attainment of budgeted number. It is a cushion made by
administration or low-level manager to make budget estimations that would not be hard to attain.
Moreover, the budget slack can take place while there is substantial uncertainty about the
outcomes to be expected in the upcoming period.
After knowing the concept as well as meaning of the budget slack, it is required to
consider certain questions such as ‘for what’ and ‘why’ for occurring concept. First of all
coming to the reality check of why this phenomenon is taking place, it can say that it takes place
because of the fraud actions of related managers, which is falsification of the data or information
in the budget report. With the budget slack, the manager is able as much as necessary to attain.
When the accounts sow higher expenses in budget, then the managers will be able to hide the
actual expenses within budget.
Reason of creation of budget slack
There are several reasons why manager practices budget slack. These reasons can be self-
interest conduct of manager as well as information asymmetry. It can see that while the top-level
management of Kuwait Petroleum Corporation places high-pressure on low-level management
for preparing budget, then they make budget slack to create budget look attainable so that they
can ignore pressure of failure.

QUESTIONS 3
Another reason for budget slack can be the uncertainty of the expected results in the
upcoming period. Under these situations, the manager of uncertainty management normally
tends to adopt conservative approach at the time of making budget. The top-level administration
gets misled in relation to real profitability of the business because of the unethical budget slack.
To overcome this, the top administration is required to review the budget of last period and
evaluate variances between actual numbers and budgeted number.
Effects of budget slack in the financial statements of entity
The manager putting the budget collectively could low-ball revenue projections. The
budget slack also pumps up the estimated expense items. However, sometimes it is actually a
case that manager is not sure of the numbers. The financial projections of company are unclear
due to the quick changes. Additionally, the new tab of products are about to be commenced. It is
analysed from the account of Kuwait Corporation Limited that expenditures of the business are
overstated due to the budget slack. It is resulted into less profit. From the annual report of
company, it is found that the consolidated expenses have reached to KD 22893.3 million.
Effects of budget slack on the organisational performance of entity
It is essential to consider the effects of budget slack on the performance of company. In a
case when internal control of budget is weaker, an approach of budget slack creation by top-level
manager will enhance the utility. Furthermore, in a case when the senior manager looking for
creating budgetary slack, the approach of budgetary internal control by budget managers will
enhance the utility. Otherwise, the strategies have no important effect on the utility. By
discovering which kinds of influences attempt were more likely to enhance these conducts, the
company can render training that heighten the awareness of the manager how others can try to
affect the decision related to budget.

QUESTIONS 4
Avoidance of budget slack
Limiting the number of managers who make budgets to a few aggressive managers can
help decrease the slack. The manager would put the expectation higher to make the issue for the
workers to move out of the ease zone and work towards getting these objectives. Most
companies will wish to end the budgetary slack but certain top-level managers can be motivated
to make this to enhance the evaluation of performance. To ignore budget slack, it is required that
budget should be used as planning. Additionally, the managers should consider it as control tool.
It should not be for the evaluation of managerial performance (Annual report, 2018).
Proper methods and tools to avoid budget slack
To avoid negative effects of budget slack, it is required to follow certain method. Following
are the tools and methods to avoid budget slack –
1. Zero-based budgeting – an issue of budget slack is mainly acute while the budget of
previous period is utilised as initial stage to make latest budget. It is known as
incremental budgeting.
2. Participative budget – the participative budget is the ideal budget procedure. Most
organisations deviate from the perfect budget procedure. A problem is that the targets set
by top-manager can be idealistically high or can permit too much budget slack (Kanan,
James & Mula, 2018).
3. Truth inducing pay scheme – the issue takes place in participative budget while the
subordinates have personal data in relation to elements that affect their performance and
the pay system is based on standard (Van der Stede, 2016).Therefore, employees have

QUESTIONS 5
advantages to keep away the data from superior so that the relatively easy standards are
set, by this means making budget slack.. Thus, truth inducing pay scheme is effective
method for avoiding slack.
4. Evaluation system – the company can decrease budget slack while it stops utilising
budget as the negative evaluation method (Okafor & Otalor, 2018).
Solutions of budget slack
The company can decrease the issue of budget slack in different manners. Firstly, it can
avoid depending on a budget as negative evaluation method. Secondly, the incentives can be
provided to the management only to get projection of budget. They can also be rendered for the
correct projection. In addition, the autonomously motivated manager tries to get budgetary target
because he or she wants to, not for the reason he or she has to. In this way, it is required by the
manager of Kuwait Corporation Limited to do work towards the budget targets in the sustainable
manner, without any negotiation of excess sources (Ling & Qingqing, 2016).
Examples of the proper budgeting vs. slack created budget
The problem of budget slack can be understand with the help of example of proper
budget and slack created budget. For example, if the department is estimated to make KD
200,000 in expenses for the year, the department management might only estimate making KD
250,000 in expenses. It means this is slack created budget. On the other hand, if department is
estimated to include KD 200,000 in the expenses, and the department manager may also estimate
creating KD 200,000 in the expenses. It is considered as proper budget (Slack, 2017).

QUESTIONS 6
Long-term effect and short-term effect of budget slack
The budget slack interferes with appropriate performance of organisation. The reason is
that the workers only have the incentives to fulfil the objectives of budget that are place
moderately low (Zahra, et. al, 2017). Further, the top level managers as well as budget managers
make attempt to increase the utility by adopting the internal control system along with budget
slack tools (Etemadi & Sirghani, 2016). It can say that sometimes the budget slack has valuable
effects (for example, to pursue approaches that need innovation as well as testing) and certain
apparently short-term decisions of management can be helpful for the long-term outcomes as
well as short-term outcomes (for example, scrapping project with doubtful fortune that ‘cuts
losses’ in place of vulnerable competitiveness).

QUESTIONS 7
References
Annual report (2018). Kuwait Petroleum Corporation. Retrieved from:
https://www.kpc.com.kw/press/KPCPublications/AnnualReports/AnnualRep2018-eng.pdf
Etemadi, H., & Sirghani, S. (2016). The effect of the budget slack creation and budget internal
control by managers on maximization of utility function in budgetary
participation. International Journal of Finance & Managerial Accounting, 1(2), 37-49.
Etemadi, H., & Sirghani, S. (2016). The effect of the budget slack creation and budget internal
control by managers on maximization of utility function in budgetary
participation. International Journal of Finance & Managerial Accounting, 1(2), 37-49.
Kanan, R. E., James, K., & Mula, J. M. (2018). Cross-Cultural Effects on the Budgeting Cycle:
The Impact of Power Distance on Participation, Voice, and Explanation in the Libyan Oil
Sector. International Journal of Business and Social Science, 9(6).
Ling, A., & Qingqing, S. (2016). Executive Power, Budget Slack and Executive
Change. Communication of Finance and Accounting, 2016(21), 17.

QUESTIONS 8
Okafor, C., & Otalor, J. (2018). Budget Participation And Budgetary Slack: Evidence From
Quoted Firms In Nigeria. International Journal of Accounting and Finance (IJAF), 7(2),
106-118.
Slack, K. (2017). Capturing Economic and Social Benefits at the Community Level. Extractive
Industries, 652.
Van der Stede, W. (2016). Reducing budget slack may lead managers to focus on the short
term. LSE Business Review, 37(3), 345-466
Zahra, F., Rohman, A., Chariri, A., & Karim, F. (2017). Does e-procurement solve Indonesia
local government budgetary slack through it adaptive culture. International journal of
civil engineering and technology, 8(8), 1001-1010.