Cost Accounting (14th Edition)

202 CHAPTER 6 MASTER BUDGET AND RESPONSIBILITY ACCOUNTING
of the company, which leads to inefficient resource planning and allocation and poor
coordination of activities across different parts of the company.
To avoid problems of budgetary slack, some companies use budgets primarily for
planning purposes. They evaluate managerial performance using multiple indicators that
take into account various factors such as the prevailing business environment and performance
relative to competitors. Evaluating performance in this way takes time and
requires careful exercise of judgment. Other companies use budgets for both planning and
performance evaluation and use different approaches to obtain accurate information.
To explain one approach, let’s consider the plant manager of a beverage bottler who
is suspected by top management of understating the productivity potential of the bottling
lines in his forecasts for the coming year. His presumed motivation is to increase the likelihood
of meeting next year’s production bonus targets. Suppose top management could
purchase a consulting firm’s study that reports productivity levels—such as the number of
bottles filled per hour—at a number of comparable plants owned by other bottling companies.
This report shows that its own plant manager’s productivity forecasts are well
below the actual productivity levels being achieved at other comparable plants.
Top management could share this independent information source with the plant
manager and ask him to explain why his productivity differs from that at other similar
plants. Management could also base part of the plant manager’s compensation on his
plant’s productivity in comparison with other “benchmark” plants rather than on the
forecasts he provided. Using external benchmark performance measures reduces a manager’s
ability to set budget levels that are easy to achieve. 6
Another approach to reducing budgetary slack is for managers to involve themselves
regularly in understanding what their subordinates are doing. Such involvement should not
result in managers dictating the decisions and actions of subordinates. Rather, a manager’s
involvement should take the form of providing support, challenging in a motivational way
the assumptions subordinates make, and enhancing mutual learning about the operations.
Regular interaction with subordinates allows managers to become knowledgeable about
the operations and diminishes the ability of subordinates to create slack in their budgets.
Part of top management’s responsibility is to promote commitment among the
employees to a set of core values and norms. These values and norms describe what constitutes
acceptable and unacceptable behavior. For example, Johnson & Johnson (J&J)
has a credo that describes its responsibilities to doctors, patients, employees, communities,
and shareholders. Employees are trained in the credo to help them understand the
behavior that is expected of them. Managers are often promoted from within and are
therefore very familiar with the work of the employees reporting to them. Managers also
have the responsibility to interact with and mentor their subordinates. These values and
practices create a culture at J&J that discourages budgetary slack.
Some companies, such as IBM and Kodak, have designed innovative performance
evaluation measures that reward managers based on the subsequent accuracy of the forecasts
used in preparing budgets. For example, the higher and more accurate the budgeted
profit forecasts of division managers, the higher their incentive bonuses.
Many of the best performing companies, such as General Electric, Microsoft, and
Novartis, set “stretch” targets. Stretch targets are challenging but achievable levels of
expected performance, intended to create a little discomfort and to motivate employees to
exert extra effort and attain better performance. Organizations such as Goldman Sachs
also use “horizontal” stretch goal initiatives. The aim is to enhance professional development
of employees by asking them to take on significantly different responsibilities or
roles outside their comfort zone.
Many managers regard budgets negatively. To them, the word budget is about as popular
as, say, downsizing, layoff, or strike. Top managers must convince their subordinates
that the budget is a tool designed to help them set and reach goals. Whatever the manager’s
perspective on budgets—pro or con—budgets are not remedies for weak management
talent, faulty organization, or a poor accounting system.
6 For an excellent discussion of these issues, see Chapter 14 (“Formal Models in Budgeting and Incentive Contracts”) of R. S. Kaplan
and A. A. Atkinson, Advanced Management Accounting, 3rd ed. (Upper Saddle River, NJ: Prentice Hall, 1998).