Simpson and Shrek the benefits expected to gain from budgetary slack.

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

In short, budgetary slack refers to the intentional distortion of information, which results in an understatement of budgeted sales and/or overstatement of budgeted costs, by individuals responsible for the budgeting process, for the purpose of including deviations that are likely to occur so that results will appear to occur within budgeted limits.

In the case study, Green Toy's budgeting procedures seem to be participative, by allowing the sales and production manager to come up with the estimated sales and production numbers. 

Personal benefits detrimental to the company

As the budgets are frequently tied to performance evaluation and individual goals, the human behaviour suggests that individuals involved in the budgeting process will then be motivated to inject budgetary slack into the budgets so as to improve their performance evaluations and compensation when they meet the budgeted goals. Budgetary slack is also incorporated into budgets in an attempt to create a "breathing space" for themselves, by estimating figures that are within reach, so that they can meet the goals much more easily.


In this case, Simpson lowered the initial sales projection from 5-10%, so as to avoid falling short of sales projections and giving themselves some leeway from the actual sales estimations, and if Simpson's remuneration is linked to how well he and his team perform beyond the budgeted figures, then that is the incentive and benefit that he can expect to gain from the use of budgetary slack. Similarly, Shrek raised the estimated production expenses by 10% and therefore costs are much easier to be kept within the budgeted figures, and if Shrek's remuneration is linked to how well he and his team kept the costs within the budgeted figures, then that is the incentive and benefit that he can expect to gain from the use of budgetary slack.



Benefits to the company

The budgetary slack may also help managers to "hedge" against uncertainty in the environment as excess resources can be drawn upon during adverse times. For example, the company keeps extra stocks so as to meet unexpected demand.

Besides that, the organisational norms also plays a part in encouraging such behaviour. If the management's philosophy is as such, and the upper management allows the use of budgetary slack and does not take a serious stance of the situation, the lower-level managers may then follow suit.


In conclusion, employees are motivated by themselves or their organization norms to utilize budgetary slack to improve their performance evaluations and compensation, shirk, consume perquisites, or hedge against uncertainty in the environment.



1b) Explain how the use of budgetary slack can adversely affect Simpson & Shrek

There are various negative effects associated with the use of budgetary slack and Simpson & Shrek who are responsible to contribute as accurately as possible to the participative budget should not misuse budgetary slack as it may not provide an accurate evaluation of the manager's performance.


Firstly, managers tend to consume budgetary slack in "good years," and they tend to convert budgetary slack to profit in "bad years." as the rewards may be linked to performance and ability to hit the target figures. The mangers will aspire to control performance measures integrated in their budgets to achieve what they perceive as attainable budgets. Let's say, if a manager is behind on his/her profit for the year, he or she will rely on the budgetary slack built into the budget to make the profit goal anyway. But if a manager is ahead on his/her profit for the year, he or she will use up the additional money left in the budget because of the budgetary slack built into it at the beginning of the year. So the managers will rarely, if ever, exceed their goals although they will almost always meet their goals. But the meeting of goals is not realistic because the goals are not real due to the budgetary slack. If such unethical behaviour is detected by the management, they might be severly dealt with.


Secondly, a deliberately understated sales budget might have serious consequences in planning other activities. For instance, production might be too low; the advertising program and distribution expense budgets may be planned incorrectly; the cash flow plans might be inaccurate; and so forth. The budget does not give the management any idea of what the coming year will actually look like, because it is not realistic.  Because changes in one component of the budget can have many different implications on the other figures due to interlink of relationship, and if the managers are not aware of these implications, they might be faced with unexpected day to day operation challenges when relying on this budget. 

Thirdly, with the injection of budgetary slack into budgeting, it reduces the motivation of the managers and their employees to maximize sales and reduce costs as the budget is easily attainable. For example, once the budgeted goals are met, there may be little motivation or incentives to push ahead for better results.  In fact, there may be some concern about beating goals for this period for fear that a new higher benchmark will be established to be achieved in a subsequent period. This can result in a natural desire to push pending transactions to future periods.  Likewise, padding the planned level of expenses can actually provide incentive to overspend, as managers fear losing money in subsequent budgets if they don't spend all of the currently budgeted funds.  This has the undesirable consequence of encouraging waste.


MR CHIK HENG, DO THIS PLEASE =) take note of the orange comments. In fact, please look through the whole theory question from ONE TO THREE.....and DID U PLAGIARIZE the STATISTICAL CHART? If so, PLEASE TRY TO EXPLAIN IN UR OWN WORDS.



Stakeholders (including Simpson and Shrek) have an indirect stake in the budgets, thus, if the loose budget covers up for inefficiency within the departments or if bonuses are paid out because the department performs beyond its budgetary goals, stakeholders' interest will be adversely affected. Because of the incorporation of budgetary slack in the budget figures, the final budget may be different from what Simpson and Shrek propose, as it may be revised and amended at higher levels of the organization. This may be because the budgeted figures are too loose. This will then adversely affect Simpson and Shrek, as the final budget may be harder to achieve then what they initially think so (without the budgetary slack) (NOT SURE WHERE TO INSERT)


Therefore, when a budget is used as an evaluation tool, it must be created carefully so as to make sure that the budget is neither too easy nor impossible to achieve. If it is too easy it will not provide a meaningful and reliable measure of efficiency and performance, and if it is too difficult to achieve, people will simply give up and not even try to meet it.  To avoid budgetary slack, the senior manager who approves the lower-level manager's budget can refuses to approve the planned amounts that have budgetary slack in them and instead insists that the lower-level manager revise his or her budgeted amounts to make them more in line with what is actually expected to occur.


Qn 2a) Are all variances worth investigating?  Discuss

No. There is no need for all variances to be investigated. This is simply because actual results will most likely differ from what is being budgeted due to many unpredictable random factors.If even the slightest variance was to be evaluated and investigated, it will cost the management a great deal of time.

Most management therefore practise management by exception in analyzing variances. It is a system of management which standards are being set for various operating activities, whereby only the information that indicates a significant deviation of actual results from the budgeted or planned results will be brought to the management's notice as an "exception". The objective of this system is to facilitate management's focus on really important tactical and strategic tasks. The manager's attention should be directed toward those parts of the organization where plans are not working out for reason or another. Time and effort should not be wasted on focusing on those parts of the organization where things are going smoothly. In management by expection, the decision that cannot be made at one level of management is passed on to the next higher level.


But under what basis is a variance considered to be significant which will warrant the attention of the management? The size of the variance itself can be the deciding factor. A variance of $10 is probably not a sum big enough to warrant attention a $1000 difference might well be worth tracking down. Another clue will be the size of the variance in relative to the amount of spending involved. A variance that is only 0.1% of spending on an item is likely to be well within the bounds one would normally expect due to random factors. On the other hand, a variance of 10% of spending is much more likely to be a signal that something is basically wrong.

A more dependable approach is to plot variance data on a statistical control chart as shown below.






































+1 Standard deviation

Var. 0


---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ---------------------------------------------- ----------------------------------------------





















-1 Standard deviation








































The basic fundamental underlying this control chart is that some random fluctuations in variances from period to period are normal and to be expected even when costs are well under control. A variance should only be investigated when it is unusual relative to that normal level of random fluctuation. Typically the standard deviation of the variance is used as the measure of the normal level of fluctuations. A rule of thumb is adopted such as "investigate all variances that are more than X standard deviations from zero." In the control chart in example below, X is 1.0. That is the rule of thumb in this company is to investigate all variances that are more than one standard deviation in either direction (favorable or unfavorable) from zero. This means that the variances in weeks 7, 11, and 17 would have been investigated, but non of others.


If the budgets and standards go according to plans, the differences between actual results and expected results will be within the preset limit of deviations.If this happens, managers can concentrate on other issues. However, if actual results do not conform to the budget and standards, the performance reporting system will send a signal to the management that an "exception" has occurred. This signal will inform the management of the difference from the budget and standards.

Qn  2b) Discuss the potential problems arising from the improper use of standard costs.


Standard costs are estimated or predetermined cost of performing an operation or producing a good or service and are developed from historical data analysis or from time and motion studies. They usually vary from actual costs, because every situation has its share of unpredictable factors.


The standard cost variance reports are usually prepared on a monthly basis and are often released days or even weeks after the end of the month. Timely, frequent reports that are approximately correct are better than infrequent reports that are very precise but out of date by the time they are released.


Labor quantity standards and efficiency variances make two important assumptions. Firstly, they assume the production process is labor-paced, so if labor works fast, the output will go up. However, output in many companies is no longer determined by how fast labor works but rather, it is determined by the processing speed of machines. Hence, the wrong components could have been used in reports. Second assumption made is that the computations assume labor is a variable cost. However, direct labor may be essentially fixed, than an undue emphasis on labor efficiency variances creates pressure to build excess work in process and finished goods inventories.


Secondly, it motivates people on the shop floor to behave unethicallly, when there is an improper use of standard cost to measure performance. Most standard costing systems measure the efficiency of the use of machinery and people using what are known as a "Volume" variance. A volume variance simply compares the cost of the labour or machines actually incurred by a production operation to make a given number of items with the amount of cost that would have been incurred at the "standard" or planned volumes.


If fewer items are made than planned, then the actual cost per item will exceed the planned for the period and the amounts of labour and overhead consumed are less than exceed the amounts that were planned. The so-called "negative" variance indicates that the production process produced at less than full capacity during the period, usually a month. Negative volume variances are very undesirable in a mass production environment as the goal of this philosophy is to achieve economies of scale and lowest per unit cost by using machines and people to the max.


One of the potential problems that might occur is that if the managers are insensitive to the source and reasonableness of the results and use variance reports without considering that the information may stale, the effects of the moves made to address their variances may not work as effectively and efficiently, hence, morale may suffer.


Also, when variances are used, an ethical issue may occur as subordinates may be tempted to cover up unfavorable variances or take actions that are not in the best interest of the company to make sure the variances are favorable. For example, workers may put on a crash effort to increase output at the end of the month to avoid an unfavorable labor efficiency variance. In the rush to produce output, quality may hence suffer. Furthermore, management by exception, by its nature, tends to focus on the negative only. As a result of the inaccurate variances reported, the actual situation may not be reflected on the statistical control chart as shown in Part 2a.

To sum up, in order to reduce the potential problems caused by the improper use of standard costs, management should exercise reasonable care and do not just focus on the negative variances, which is commonly the management style of "management by exception" and also to take note of the possible effects. As a good practice, companies should report variances and other key operating data daily or even more frequently. Furthermore, to reduce the occurrence of inaccurate results being reflected on the statiiscal control chart, employees should receive positive reinforcement for work well done and make proper adjustments so that the overall profit planning is up-to-date.


Qn 3a) In your opinion, what does a cost analyst need to know to build useful financial models for Cost Volume Profit analysis or budgeting?

The Cost Volume Profit (CVP) Model is a financial tool that shows the impact of changes in sales volume, prices and costs on the profits, henceforth determining the volume required to breakeven, calculate the volume needed to achieve a desired level of profit, as well as, estimate the profit when the CVP variables changes. The budgeting process involves planning and estimating the future revenues and expenses that may occur for a specified period of time.

In order to build useful financial models for both Cost Volume Profit analysis and budgeting, there are various areas that the cost analyst needs to look at:

Firstly, the cost analyst needs to identify the purposes and the users of the model.  The purposes and likely users will guide the cost analyst in building effective and useful financial models and arrange the information so as to cater to the needs of the different groups.


Secondly, the analyst should plan and decide on the elements in the financial models.

For the CVP Model, this includes keying in the activity level, selling price per unit, variable cost per unit and as well as determining the total fixed costs and sales mix. A master budget would consist of the operating budget (sales, production, and selling and administrative expenses) and financial budget (cash, balance sheet and income statement, and capital expenditure). Having the flow in mind, it will assist the cost analyst in creating links and further emphasise on the relationships between various variables and worksheets.


Thirdly, he or she needs to come up with a list of assumptions for the financial models.

The CVP Model assumes that the sales price, variable cost per unit, total fixed cost and sales mix in multi-product companies will be constant within the relevant range of activity. Also, the number of units produced will be equivalent to the number of units sold, hence there will be no ending inventory. The productivity and efficiency of the workers and the machinery are assumed to be constant too.


Last but not least, it is also important to determine the different cost behaviours which may affect the results.

Fixed Costs

Fixed costs are those costs that your business incurs regardless of sales volume. Examples would be rent and insurance.

Variable Costs    

Variable costs are those costs that are directly affected by sales volume. Examples would be salaries expenses for workers.

Semi-Variable Costs

Semi-variable costs are those costs that increase with sales volume but not directly as with variable costs. An example would be the telephone expenses, where there will be a fixed monthly subscription cost and the remaining variable expenses are charged in respect to the number of minutes used.


Lastly, the cost analyst should be aware of the changes in the environment which may, directly or indirectly, affect the components in the financial models.


The financial models should take into consideration changes in the revenues and costs caused by political factors, competition in the industry, seasonal conditions, economic conditions, consumers' preferences, purchasing power etc. For example, inflation rate may fluctuate across the periods and this might affect the forecasts and actual results. Different tax rates also may affect the desired before-tax profit.

3b) Financial models can help define future risks and uncertainties.  What do you think is the key to building and using such financial planning models successfully?

Financial modelling is an invaluable tool to assist in the preparation of a business plan.

Before using a financial model to help plan the future of a business, the cost analyst or manager should determine the purpose of the planning model, the target audience, and the model period; ensure that all the key assumptions and data are up-to-date and have been adequately researched, and confirm their overall trend; and consider strategic issues relating to sales, profitability, financing, and so on.


In actual practices, most models ignore depreciation and taxes and are based on accrual rather than cash basis, which may not accurately reflect the financial cash flows. Using percentage of sales to derive total costs is also not realistic because there is the presence of fixed costs.

© 2009 McGraw-Hill Ryerson Limited


In businesses, we should not substitute business planning for financial forecasting. Sufficient considerations should be given to working capital requirements, historical trends and performances levels. We should neither overestimate market shares and growth, sales, and profit levels, nor underestimate costs and delays that are likely to arise. We should not make unduly optimistic assumptions about the availability of financing, and should be cautious of breaching financial guidelines. Furthermore, we should be mindful of seeking spurious accuracy and failing to recognize matters of strategic importance


Adjustments should be made for the above pitfalls and considerations, as they may underestimate the resources needed for the business. A realistic point of view should always be taken, and forecasts should project the "worst", "most likely" and "best" case scenarios.


The reliability and usefulness of these financial projections will be determined by the quality and reliability of the underlying assumptions researched. For example, if sales or cost forecasts are unrealistic or inadequately researched, the value of the model would be greatly diminished. Financial model is of little benefit if unsupported by research or are based only on speculation or desired figures.