CHAPTER 10

USING BUDGETS TO ACHIEVE ORGANIZATIONAL OBJECTIVES

TRUE/FALSE

1. Budgeting includes discretionary spending if it impacts the firms’ production capacity.

a. True
b. False

2. A budget is a qualitative expression of the cash inflows and outflows that show whether the
current operating plan will meet the firm’s organizational objectives.
a. True
b. False

3. Budgets can play both planning and control roles for management.
a. True
b. False

4. The usual starting point in budgeting is to make a forecast of net income.

a. True
b. False

5. The production plan should be based on the sales plan.

a. True
b. False

6. If amounts in the sales forecast change, amounts in the production budgets will also
change.
a. True
b. False

7. After a budget is agreed upon and finalized by the management team, the amounts should
not be changed for any reason.
a. True
b. False

8. Budgets can be prepared for any time period, but are usually developed for one year.
a. True
b. False

9. Zero-based budgeting requires that proponents of discretionary expenditures justify these

outlays for each budgeting period.
a. True
b. False

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10. Sensitivity analysis enables planners to identify the estimates that are critical for the
decision under consideration.
a. True
b. False

11. The essence of variance analysis is that it captures a departure from what was expected.
a. True
b. False

12. It is most meaningful to compare cost targets in the master budget to actual cost results.
a. True
b. False

13. A favorable variance indicates management’s attention is not needed.

a. True
b. False

14. An unfavorable variance may be due to poor planning rather than due to inefficiency.
a. True
b. False

15. If standards are lax, cost variances will tend to be favorable.

a. True
b. False

16. To compute the direct material price variance, the actual cost of material is compared to
the amount budgeted at the beginning of the year for the material.
a. True
b. False

17. The use of high-quality raw materials is likely to result in a favorable material quantity
variance and an unfavorable material price variance.
a. True
b. False

18. The labor rate variance is likely to be unfavorable if higher-skilled workers are put on a
job.
a. True
b. False

19. Planning variances are the focus of cost control.

a. True
b. False

20. The role of budgeting in planning and control is more important in manufacturing than in a
not-for-profit environment.
a. True
b. False

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21. When the operating budget is used as a control device, managers are more likely to be
motivated to budget higher sales than actually anticipated.
a. True
b. False

22. Budgeting slack is most likely to occur when a firm uses the budget only as a planning
device and not for control.
a. True
b. False

23. Authoritative budgeting occurs when a superior simply tells subordinates what their budget
will be.
a. True
b. False

MULTIPLE CHOICE

24. A budget should/can do all of the following EXCEPT that it:

a. should be prepared by managers from different functional areas working
independently of each other
b. should be adjusted if new opportunities become available during the year
c. can help management allocate limited resources
d. can become the performance standard against which firms can compare the actual
results

25. Budgeting provides all of the following EXCEPT:

a. a means to communicate the organization's short-term goals to its members
b. support for the management functions of planning and coordination
c. a means to anticipate problems
d. an ethical framework for decision making

26. Budgeting always includes:

a. control
b. planning of short-term activities
c. evaluating performance
d. preparing pro forma financial statements

27. Budgeting does NOT require:

a. knowledge of the organization’s activities
b. specialized expertise in financial management and control
c. knowledge about how activities affect costs
d. the ability to see how the organization’s different activities fit together

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28. All of the following are true statements about the role of budgets and budgeting EXCEPT
that:
a. a budget is a quantitative summary of the expected allocations and financial
consequences of the organization’s short-term operating activities
b. budgeting includes the process of estimating money inflows and outflows to
determine a financial plan that will meet an organization’s objectives
c. the difference between actual results and the budget plan are called variances
d. budgeting solves most business challenges because it coordinates activities and
communicates the organization’s short-term goals to its members

29. In regard to the amount of detail, a budget should:

a. show the detail for each product
b. group products into pools of products
c. strike a balance between detail and aggregated information
d. not consider the cost of gathering the information

30. If initial budgets prove unacceptable, planners achieve the MOST benefit from:
a. repeating the budgeting cycle with a new set of decisions
b. deciding not to budget this year
c. accepting an unbalanced budget
d. using last year’s budget

31. When discussing the roles of budgets, a planning role in the budgeting process includes:
a. measuring outcomes against planned amounts
b. developing the master budget
c. assessing performance
d. reporting actual amounts at the end of the budgeting period

32. When discussing the roles of budgets, a control role includes:

a. identifying organizational objectives and short-term goals
b. developing long-term strategies and short-term plans
c. measuring and assessing performance against budgeted amounts
d. developing the master budget

33. Operating budgets and financial budgets:

a. combined form the master budget
b. are prepared before the master budget
c. are prepared after the master budget
d. have nothing to do with the master budget

34. Operating budgets include all of the following EXCEPT:

a. a sales plan
b. a labor hiring and training plan
c. an administrative and discretionary spending plan
d. expected financial results

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35. Operating budgets include the:
a. projected balance sheet
b. projected income statement
c. capital spending plan
d. expected cash flow statement

36. Financial budgets are prepared:

a. to specify expectations for selling, purchasing, and production
b. to evaluate the financial results of the proposed decisions
c. so that financial statements can be prepared for shareholders
d. to plan for production capacity

37. Financial budgets include the:

a. capital spending plan
b. production plan
c. labor hiring and training plan
d. expected cash flow statement

38. __________ include an expected cash flow statement, the projected balance sheet, and the
projected income statement.
a. Annual reports
b. Financial budgets
c. Operating budgets
d. Capital budgets

39. __________ provide(s) the starting point and the framework for evaluating the budgeting
process.
a. The sales plan
b. Organizational goals
c. The production plan
d. Expected cash flows

40. A demand forecast is:

a. an estimate of sales demand at a specified selling price for each product
b. developed primarily to prepare next year’s marketing campaign
c. an estimate of market demand based on the amount sold in the previous year
d. a summary of product costs that influence pricing decisions

41. The budgeting process is MOST strongly influenced by the:

a. capital spending plan
b. statement of expected cash flows
c. demand forecasts
d. production plan

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42. In which order are the following developed?
A = Production plan B = Materials purchasing plan
C = Demand forecast D = Sales plan
a. first to last: A, B, C, D
b. first to last: C, D, A, B
c. first to last: D, C, B, A
d. first to last: C, A, D, B

43. The __________ provides the foundation for the production plans.
a. inventory policy
b. sales plan
c. administrative and discretionary spending plan
d. capital spending plan

44. The sales plan identifies:

a. expected cash flows from the sales of each product
b. actual sales from last year for each product
c. the budgeted level of sales for each product
d. the variance of sales from actual for each product

45. The __________ summarizes planned revenues from each product.

a. capital spending plan
b. production plan
c. administrative and discretionary spending plan
d. sales plan

46. Which of the following statements is TRUE regarding capacity resources?

a. Raw materials and supplies are examples of intermediate-term resources.
b. Long-term capacity usually varies directly with production levels.
c. Flexible resources are usually purchased to acquire intermediate-term capacity.
d. Long-term capacity resources are expensive and referred to as “committed”
resources.

47. __________ specifies when items such as acquisitions for buildings and special-purpose
equipment must be made to meet activity level objectives.
a. The capital-spending plan
b. The production plan
c. The materials purchasing plan
d. The administrative and discretionary spending plan

48. The sales plan and inventory plan is compared to available productive capacity levels and
__________ is determined.
a. an aggregate plan
b. a new sales plan
c. a materials purchasing plan
d. an administrative and discretionary spending plan

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49. Aggregate planning:
a. determines the projected financial statements
b. compares the sales plan with the demand forecast
c. assesses the feasibility of the proposed production plan
d. provides a detailed production schedule for all product lines

50. Discretionary expenditures:

a. are usually planned for first
b. are amounts paid for the use of flexible resources
c. are not determined by the organization’s level of production
d. increase in amount during periods of greater activity

51. __________ summarizes expenditures for advertising and research and development.
a. The labor hiring and training plan
b. The production plan
c. The administrative and discretionary spending plan
d. The aggregate plan

52. All of the following are true regarding the labor hiring and training plan EXCEPT that it:
a. may include retraining plans to redeploy employees to other parts of the organization
b. determines discretionary spending for research and development
c. works backward from the date when personnel are needed
d. can include plans for both expansion and contraction

53. Financial analysts use the expected cash flow statement to do all of the following
EXCEPT:
a. plan for when excess cash is generated
b. plan for short-term cash investments
c. project cash shortages and plan a strategy to deal with the shortages
d. project sales

54. The expected cash flow statement does NOT include:

a. cash inflows from the collection of receivables
b. cash outflows paid toward committed resources
c. all sales revenues
d. interest paid and collected

55. The financing section of the expected cash flow statement includes:
a. cash flows from retail sales
b. borrowing made and repaid
c. amounts paid for advertising costs
d. cash outflows for flexible resources

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 56 THROUGH 59.
For the next six months, Berry Company projects the following information (in units).

July Aug. Sept. Oct. Nov. Dec.

Retail demand 100 100 150 150 200 200
Dealer demand 200 250 300 350 400 450
Shop capacity 500 500 500 500 500 500
Painting capacity 350 350 350 600 600 600

Demand drives production for that month and cannot be carried over from one month to another.
Retail customers are satisfied first.

56. The production for July is projected to be:

a. 100 units
b. 300 units
c. 350 units
d. 500 units

57. The number of dealer units that will be produced and sold in September is:
a. 300 units
b. 350 units
c. 500 units
d. 200 units

58. Painting capacity appears to be:

a. short-term capacity
b. intermediate-term capacity
c. long-term capacity
d. total demand

59. In November, production appears to be limited by:

a. short-term capacity
b. intermediate-term capacity
c. long-term capacity
d. total demand

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 60 THROUGH 65.

The following information pertains to the October operating budget for Calista Corporation.
 Budgeted sales for October $200,000 and November $400,000.
 Collections for sales are 60% in the month of sale and 40% the next month.
 Gross margin is 30% of sales.
 Administrative costs are $20,000 each month.
 Beginning accounts receivable (October 1) $40,000.
 Beginning inventory (October 1) $28,000.
 Beginning accounts payable (October 1) $120,000. (All from inventory purchases.)
 Purchases are paid in full the following month.
 Desired ending inventory is 20% of next month’s cost of goods sold (COGS).
 No loans are outstanding on October 1
60. For October, budgeted cash collections are:

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 a. $40,000
b. $120,000
c. $160,000
d. None of the above is correct.

61. At the end of October, budgeted accounts receivable is:

a. $40,000
b. $80,000
c. $120,000
d. None of the above is correct.

62. For October, budgeted cost of goods sold is:

a. $40,000
b. $60,000
c. $80,000
d. None of the above is correct.

63. For October, budgeted net income is:

a. $40,000
b. $60,000
c. $80,000
d. None of the above is correct.

64. For October, budgeted cash payments for purchases are:

a. $28,000
b. $120,000
c. $140,000
d. None of the above is correct.

65. At the end of October, budgeted ending inventory is:

a. $40,000
b. $56,000
c. $80,000
d. None of the above is correct.

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 66 THROUGH 69.
The following information for the second quarter of 2006 pertains to Huffman Company:

Month Sales Purchases

April $45,000 $24,000
May $60,000 $30,000
June $75,000 $42,000

 Cash is collected from customers in the following manner:

Month of sale 30%
Month following the sale 70%

 40% of purchases are paid for in cash in the month of purchase, and the balance is paid
the following month.

 Labor costs are 20% of sales. Other operating costs are $22,500 per month (including
$6,000 of depreciation). Both of these are paid in the month incurred.

 The cash balance on June 1 is $6,000. A minimum cash balance of $4,500 is required at
the end of the month. Money can be borrowed in multiples of $1,500.
* No loans outstanding on June 1.

66. How much cash will be collected from customers in June?

a. $64,500
b. $70,500
c. $75,000
d. None of the above is correct.

67. How much cash will be paid to suppliers in June?

a. $34,800
b. $28,000
c. $44,000
d. None of the above is correct.

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68. How much cash will be disbursed for labor and operating costs in June?
a. $31,500
b. $35,000
c. $44,200
d. $48,200

69. What is the ending cash balance for June?

a. ($25,000)
b. $3,000
c. $3,200
d. $5,700

70. In __________, as one budget period passes, planners delete that budget period from the
master budget and add another one.
a. zero-based budgeting
b. periodic budgeting
c. incremental budgeting
d. continuous budgeting

71. Although planners update or revise the budgets during the period, __________ is typically
performed once per year.
a. zero-based budgeting
b. periodic budgeting
c. incremental budgeting
d. continuous budgeting

72. __________ requires that each discretionary expenditure be justified.

a. Zero-based budgeting
b. Periodic budgeting
c. Incremental budgeting
d. Continuous budgeting

73. __________ bases a period's expenditure level for a discretionary item on the amount spent
on that item during the previous period.
a. Zero-based budgeting
b. Periodic budgeting
c. Incremental budgeting
d. Continuous budgeting

74. In zero-based budgeting:

a. the prior year’s budgeted amounts or actual results are used to build the new
operating budget
b. the budget is prepared by the top managers
c. managers must justify each item within the operating budget as if it were a new
budget item
d. the budget is updated every month

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75. __________ is the process of varying key estimates to identify those estimates that are the
most critical to a decision.
a. A demand forecast
b. A sensitivity analysis
c. A pro forma income statement
d. The cash flow statement

76. Assume only the specified parameters change in a sensitivity analysis. If the contribution
margin increases by $2 per unit then operating profits will:
a. also increase by $2 per unit
b. increase by less than $2 per unit
c. decrease by $2 per unit
d. be indeterminable

77. Assume that only the specified parameters change in a sensitivity analysis. The
contribution margin ratio increases when:
a. total capacity-related (fixed) costs increase
b. total capacity-related (fixed) costs decrease
c. flexible (variable) costs per unit increase
d. flexible (variable) costs per unit decrease

78. The break-even point in units decreases if the:

a. flexible (variable) cost per unit increases
b. total capacity-related (fixed) costs decrease
c. contribution margin per unit decreases
d. selling price per unit decreases

79. (CPA adapted, November 1992) The strategy MOST LIKELY to reduce the break-even
point would be to:
a. increase both the capacity-related (fixed) costs and the contribution margin per unit
b. decrease both the capacity-related (fixed) costs and the contribution margin per unit
c. decrease the capacity-related (fixed) costs and increase the contribution margin per
unit
d. increase the capacity-related (fixed) costs and decrease the contribution margin per
unit

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 80 THROUGH 82.

DH Manufacturing produces a single product that sells for $8. Variable (flexible) costs per unit
equal $3.20. The company expects the total fixed (capacity-related) costs to be $7,200 for the
next month at the projected sales level of 20,000 units. In an attempt to improve performance,
management is considering a number of alternative actions. Each situation is to be evaluated
separately.

80. What is the current break-even point in terms of number of units for the next month?
a. 1,500 units
b. 2,250 units
c. 3,333 units
d. None of the above is correct.
81. Suppose that DH Manufacturing’s management believes that a $1,600 increase in the
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monthly advertising expense will result in a considerable increase in sales. How much must sales
increase in a month to justify this additional expenditure?
a. 200 units
b. 334 units
c. 500 units
d. None of the above is correct.

82. Suppose that DH Manufacturing's management believes that a 10% reduction in the selling
price will result in a 10% increase in sales. If this proposed reduction in selling price is
implemented, then:
a. profit will decrease by $8,000 in a month
b. profit will increase by $8,000 in a month
c. profit will decrease by $16,000 in a month
d. profit will increase by $16,000 in a month

83. The PRIMARY reason for using cost variances is:

a. that they diagnose the cause of a problem and what should be done to correct it
b. for superiors to communicate expectations to lower level employees
c. to administer appropriate disciplinary action
d. for financial control of operating activities

84. A favorable cost variance of significant magnitude:

a. is the result of good planning
b. may lead to improved production methods if it is investigated
c. indicates that management does not need to be concerned about lax standards
d. does not need to be investigated

85. The variances that should be investigated by management include:

a. only unfavorable variances
b. only favorable variances
c. all variances, both favorable and unfavorable
d. both favorable and unfavorable variances that are considered significant in amount
for the company

86. A flexible budget contains:

a. cost targets for actual output
b. cost targets for planned output
c. the difference between planned and actual output
d. actual costs for actual output

87. All of the following are true of flexible budgets EXCEPT that they:
a. use the same flexible (variable) cost per unit as the master budget
b. result in higher total costs for greater levels of production
c. allow comparison of actual results to targets based on the achieved level of
production
d. reflect the same level of production as the master budget

88. The variance that LEAST affects cost control is the __________ variance.
a. flexible budget
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 b. direct material price
c. planning
d. direct labor efficiency

89. A flexible budget variance is $800 favorable for unit-related costs. This indicates that:
a. actual costs were $800 more than the master budget
b. actual costs were $800 less than standard for the achieved level of activity
c. the sum of the planning and efficiency variances totals $800
d. actual costs were $800 less than for the planned level of activity

90. A favorable price variance for direct materials indicates that:

a. a lower price than expected was paid for materials
b. a higher price than expected was paid for materials
c. less material was used during production than planned for actual output
d. more material was used during production than planned for actual output

91. A favorable efficiency variance for direct labor indicates that:

a. a lower wage rate than expected was paid for direct labor
b. a higher wage rate than expected was paid for direct labor
c. less direct labor hours were used during production than expected for actual output
d. more direct labor hours were used during production than expected for actual output

92. A favorable wage rate variance for direct labor might indicate that:
a. employees were paid more than planned
b. a corporate-wide wage adjustment was implemented
c. less skilled and qualified employees are being hired
d. an efficient labor force

93. An organization planned to use $82 of material per unit of activity but it actually used $80
of material per unit of activity, and it planned to make 1,200 units but it actually made
1,000 units. The flexible budget amount for materials is:
a. $80,000
b. $82,000
c. $96,000
d. $98,400

94. An organization planned to use $82 of material per unit of activity but it actually used $80
of material per unit of activity, and it planned to make 1,200 units but it actually made
1,000 units. The flexible budget variance for materials is:
a. $2,000 favorable
b. $14,000 unfavorable
c. $16,400 unfavorable
d. $2,400 favorable

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95. An organization planned to use $82 of material per unit of activity but it actually used $80
of material per unit of activity, and it planned to make 1,200 units but it actually made
1,000 units. The planning variance is:
a. $2,000
b. $14,000
c. $16,400
d. $2,400

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 96 THROUGH 99.

These questions refer to flexible budget variance formulas with the following descriptions for
the variables: A = Actual; P = Price; Q = Quantity; S = Standard.

96. The best label for the formula (AQ – SQ) x SP is the:
a. materials quantity variance
b. materials price variance
c. total cost variance for materials
d. labor wage rate variance

97. The best label for the formula (AP – SP) x AQ is the:
a. materials quantity variance
b. materials price variance
c. total cost variance for materials
d. labor efficiency variance

98. The best label for the formula [(AP) x (AQ)– (SP) x (AQ)] is the:
a. materials quantity variance
b. materials price variance
c. total cost variance for materials
d. labor efficiency variance

99. The best label for the formula [(AP) x (AQ)– (SP) x (SQ)] is the:
a. materials quantity variance
b. materials price variance
c. total cost variance for materials
d. labor efficiency variance

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 100 THROUGH 105.
Tripani Industries, Inc., (TII) developed the following standard costs for direct material and
direct labor for one of their major products, the 10-gallon plastic container.

Standard quantity Standard price

Direct materials 0.10 pounds $30 per pound
Direct labor 0.05 hours $15 per hour

During August, TII produced and sold 5,000 containers using 490 pounds of direct materials at
an average cost per pound of $32 and 250 direct labor hours at an average wage of $15.25 per
hour.

100. August’s direct material cost variance was:

a. $980 unfavorable
b. $300 favorable
c. $680 unfavorable
d. None of the above is correct.

101. August’s direct material price variance was:

a. $980 unfavorable
b. $300 favorable
c. $680 favorable
d. None of the above is correct.

102. August’s direct material quantity variance was:

a. $980 unfavorable
b. $300 favorable
c. $680 favorable
d. None of the above is correct.

103. August’s direct material planning variance was:

a. $134,320 favorable
b. $135,300 unfavorable
c. $680 unfavorable
d. indeterminable using the above information

104. August’s direct labor rate variance was:

a. $62.50 unfavorable
b. $62.50 favorable
c. $71,187.50 favorable
d. None of the above is correct.

105. August’s direct labor efficiency variance was:

a. $62.50 unfavorable
b. $62.50 favorable
c. $71,187.50 favorable
d. None of the above is correct.

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 106 THROUGH 111.
Community Manufacturing Inc., developed the following standard costs for direct material and
direct labor for one of their major products, the 30-gallon heavy-duty plastic container.

Standard quantity Standard price

Direct materials 0.20 pounds $25 per pound
Direct labor 0.10 hours $15 per hour

During May, Community produced and sold 10,000 containers using 2,200 pounds of direct
materials at an average cost per pound of $24 and 1,050 direct labor hours at an average wage of
$14.75 per hour.

106. May’s direct material price variance was:

a. $2,800 favorable
b. $2,200 favorable
c. $5,000 unfavorable
d. None of the above is correct.

107. May’s direct material quantity variance was:

a. $2,800 unfavorable
b. $2,200 favorable
c. $5,000 unfavorable
d. None of the above is correct.

108. May’s direct labor cost variance was:

a. $750.00 unfavorable
b. $262.50 favorable
c. $487.50 unfavorable
d. indeterminable using the above information

109. May’s direct labor rate variance was:

a. $750.00 unfavorable
b. $262.50 favorable
c. $487.50 favorable
d. indeterminable using the above information

110. May’s direct labor efficiency variance was:

a. $750.00 unfavorable
b. $262.50 favorable
c. $487.50 favorable
d. indeterminable using the above information

111. May’s direct labor planning variance was:

a. $134,512.50 favorable
b. $ 487.50 favorable
c. $ 487.50 unfavorable
d. indeterminable using the above information

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 112 THROUGH 115.
The actual information pertains to the month of June. As part of the budgeting process, Petrified
Products Company developed the following master budget for June. The manager, Pete, is in the
process of preparing the flexible budget and understanding the results.

Master Flexible Actual

Budget Budget Results
Sales volume (in units) # 25,000 # 20,000
========
Sales revenues $1,250,000 $ $1,000,000
Flexible (variable) costs 600,000 $ _________ 512,000

Contribution margin 650,000 $ 488,000

Capacity-related (fixed) costs 450,000 $ _________ 458,000

Operating profit $ 200,000 $ $ 30,000

112. The flexible budget will report $__________ for the flexible (variable) costs.
a. $512,000
b. $600,000
c. $480,000
d. $640,000

113. The flexible budget will report $__________ for the capacity-related (fixed) costs.
a. $458,000
b. $450,000
c. $360,000
d. $572,500

114. The flexible budget variance for flexible (variable) costs is:
a. $32,000 unfavorable
b. $120,000 unfavorable
c. $32,000 favorable
d. $120,000 favorable

115. The PRIMARY reason for low operating profits in June was:
a. the flexible budget variance for flexible (variable) costs
b. increased capacity-related (fixed) costs
c. a poor management accounting system
d. lower sales volume than planned

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THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 116 THROUGH 117.
Abita Manufacturing has prepared the following flexible budget for October and it is in the
process of interpreting the variances. F denotes a favorable variance and U denotes an
unfavorable variance.
Flexible ------------Variances-------------
Budget Price/Rate Use/Efficiency
Material A $20,000 $1,000 F $3,000 U
Material B 30,000 500 U 1,500 F
Direct labor 40,000 500 U 2,500 F

116. The MOST LIKELY explanation of the above variances for Material A is that:
a. a lower price than expected was paid for Material A
b. higher quality raw materials were used than were planned
d. the company used a new supplier
d. Material A used during October was $2,000 less than expected

117. The MOST LIKELY explanation of the above direct labor variances is that:
a. the average wage rate paid to employees was less than expected
b. employees did not work as efficiently as expected to accomplish the job
c. the company may have assigned more experienced employees this month than
originally planned
d. management may have a problem with budget slack and may be using lax standards
for both labor wage rates and expected efficiency

118. In the service sector, __________ rather than machines usually represent(s) the capacity
constraint, which underscores the importance of budgeting even in nonmanufacturing
organizations.
a. people
b. knowledge
c. familiarity with processes
d. potential for sales

119. _________ occur(s) when a superior simply tells subordinates what their budget will be.
a. Authoritative budgeting
b. Stretch targets
c. Consultative budgeting
d. Budget slack

120. _________ mean(s) that the organization will attempt to reach much higher goals with the
current budget.
a. Authoritative budgeting
b. Stretch targets
c. Consultative budgeting
d. Budget slack

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121. _________ occur(s) when managers ask subordinates to discuss their ideas about the
budget, but no joint decision-making occurs.
a. Authoritative budgeting
b. Stretch targets
c. Consultative budgeting
d. Budget slack

122. _________ involve(s) a joint decision-making process in which all parties agree about
setting the budget targets.
a. The pseudo-participation
b. Budgeting games
c. Budget slack
d. The participation method

123. _________ occur(s) when subordinates ask for excess resources above and beyond what
they need to accomplish budget objectives.
a. Pseudo participation
b. Effective budgeting
c. Budget slack
d. Participative budgeting

124. The BEST description of participative budgeting is that:

a. lower-level managers and employees initially prepare the budget
b. managers and employees at many levels are involved with the budgeting process
c. the budget is prepared by the top managers
d. top management sets figures for all operating activities and these amounts are not
negotiable

250
EXERCISE/PROBLEMS

125. For the next quarter, Trafton Manufacturing projects the following information (in units).

July Aug. Sept.

Retail demand 4,000 4,000 6,000
Dealer demand 8,000 10,000 12,000
Shop capacity 13,000 13,000 13,000
Painting capacity 12,000 12,000 12,000

Demand drives production for that month and cannot be carried over from one month to
another. Retail customers are satisfied first.

Required:
a. Prepare a schedule that shows the number of retail and dealer units to be made and
sold each month.
b. Review the above information and comment on your observations. What suggestions
do you have for Trafton Manufacturing?

126. The following information pertains to Ortega Corporation:

Month Sales Purchases

July $15,000 $5,000
August 17,000 6,000
September 19,000 7,000
October 21,000 8,000
November 24,000 9,000
December 30,000 10,000

 Cash is collected from customers in the following manner:

Month of sale (2% cash discount) 30%
Month following sale 50%
Two months following sale 15%
Amount uncollectible 5%

 40% of purchases are paid for in cash in the month of purchase, and the balance is paid
the following month.

Required:
a. Prepare a summary of cash collections for the 4th quarter.
b. Prepare a summary of cash disbursements for the 4th quarter.

127. The following information pertains to Maxi Corporation:

251
 Month Sales Purchases
July $40,000 $20,000
August 30,000 15,000
September 20,000 10,000
October 50,000 25,000
November 60,000 30,000
December 70,000 35,000

 Cash is collected from customers in the following manner:

Month of sale 20%
Month following the sale 50%
Two months following sale 28%
Amount uncollectible 2%
 Thirty percent of purchases are paid for in cash in the month of purchase, and the
balance is paid the following month. A 2% discount is allowed on purchases paid for
in the month of purchase.
 Labor costs equal 20% of sales; other operating costs of $5,000 per month (including
$2,000) of depreciation. Both are paid in the month incurred.
 The cash balance on October 1 is $4,300. A minimum cash balance of $4,000 is
required at the end of the month. Money is borrowed in multiples of $1,000.
 The company will issue $6,000 of common stock and pay $10,000 in dividends in
October.
 There is no debt outstanding at October 1.

Required:
Prepare a projected cash flow statement in good form for the month ended October 31.

128. Sun Inc. sells a single product. The company's 2007 income statement is given below.

Sales (4,000 units) $800,000

Less flexible (variable) expenses $200,000
Less capacity-related (fixed) expenses $300,000

In an attempt to improve performance, Jo, the manager is considering a number of

alternative actions. Each situation is to be evaluated separately.

Required:
a. Calculate operating income and the break-even point in units and dollars for 2007.
b. Jo believes that a $100,000 increase in equipment improvements will increase sales
considerably. How much must sales increase to justify this capital expenditure?
c. Jo believes that flexible costs can be decreased by 10%. As a result, she wants to
reduce the selling price by 2% in anticipation of a 5% increase in sales. What are
projected profits if these proposals are implemented?

252
129. Tao Industries, Inc.developed standard costs for direct material and direct labor. In 2005,
Tao estimated the following standard costs for one of their major products, the 50-gallon
plastic container.
Standard quantity Standard price
Direct materials 0.25 pounds $40 per pound
Direct labor 0.03 hours $18 per hour

During August, Tao produced and sold 8,000 containers using 1,900 pounds of direct
materials at an average cost per pound of $41 and 250 direct labor hours at an average
wage of $18.25 per hour. Determine the following variances for August:

Required:
a. Total direct material cost variance.
b. Direct material price variance.
c. Direct material quantity variance.
d. Total direct labor cost variance.
e. Direct labor rate variance.
f. Direct labor efficiency variance.

130. As part of the budgeting process, Drago Company developed the following master budget
for September. Drago is in the process of preparing the flexible budget and understanding
the results.

Master Flexible Actual

Budget Budget Results
Sales volume (in units) # 30,000 # 25,000
========
Sales revenues $3,600,000 $ $3,000,000
Flexible (variable) costs 2,160,000 $ _________ 1,930,000

Contribution margin 1,440,000 $ 1,070,000

Capacity-related (fixed) costs 900,000 $ _________ 970,000

Operating profit $ 540,000 $ $ 100,000

Required:
a. Prepare the flexible budget in the area provided above.
b. Determine the flexible budget variance for flexible (variable) costs.
c. Determine the planning variance for flexible (variable) variance costs.
d. Should the manager be congratulated for keeping costs under control? Explain.

253
131. Grey Manufacturing has prepared the following flexible budget for October and it is in the
process of interpreting the variances. F denotes a favorable variance and U denotes an
unfavorable variance.
Flexible ----------------Variances--------------- Actual
Budget Price/Rate Quantity/Efficiency Results
Material A $30,000 $1,000F $3,000U $32,000
Material B 40,000 500U 1,500F 39,000
Direct labor 50,000 500U 2,500F 48,000

Required:
a. Explain what each of the following variances indicates.
1. For Material A, the favorable price variance indicates that…
2. For Material A, the unfavorable quantity variance indicates that…
3. For direct labor, the unfavorable price variance indicates that…
4. For direct labor, the favorable efficiency variance indicates that…

b. Which two variances do you think should be investigated by management? Why?

254
CRITICAL THINKING/ESSAY

132. What is budgeting? What is its role?

133. Describe the benefits to an organization of preparing an operating budget.

134. Describe operating and financial budgets and give at least two examples of each that are
discussed in the textbook.

135. Discuss the importance of the sales forecast and items that influence its accuracy.

136. Discuss the terms discretionary expenditures and committed expenditures and give an
example of each.

137. Explain when a manager would use what-if analysis.

138. Are negative variances always unfavorable and positive variances always favorable?
Explain.

139. Explain what each of the following variances indicates, and discuss what conditions might
have caused each variance.
Direct material price variance: $1,000 U
Direct material quantity variance: $1,500 F
Direct labor rate variance: $800 F
Direct labor efficiency variance: $300 U

140. What is the primary role of the flexible budget?

141. How is the role of budgeting similar for a manufacturing firm and a not-for-profit
organization?

142. Describe some of the drawbacks of using the operating budget as a control device.

143. What is stretch budgeting? Why is it used?

144. What is budget slack? What are the pros and cons of building slack into the budget from
the point of view of (a) an employee and (b) a senior manager?

255
 CHAPTER 10 SOLUTIONS
USING BUDGETS TO ACHIEVE ORGANIZATIONAL OBJECTIVES

TRUE/FALSE

LO1 1. b
LO1 2. b
LO2 3. a
LO3 4. b
LO3 5. a

LO3 6. a
LO3 7. b
LO4 8. a
LO4 9. a
LO5 10. a

LO6 11. a
LO6 12. b
LO6 13. b
LO6 14. a
LO6 15. a

LO6 16. b
LO6 17. a
LO6 18. a
LO6 19. b
LO7 20. b

LO8 21. b
LO8 22. b
LO8 23. a

256
MULTIPLE CHOICE

LO1 24. a LO3 59. c LO6 94. a

LO1 25. d LO3 60. c LO6 95. c
LO1 26. b,d LO3 61. b LO6 96. a
LO1 27. b LO3 62. d LO6 97. b
LO1 28. d LO3 63. a LO6 98. b

LO1 29. c LO3 64. b LO6 99. c

LO1 30. a LO3 65. b LO6 100. c
LO2 31. b LO3 66. a LO6 101. a
LO2 32. c LO3 67. a LO6 102. b
LO3 33. a LO3 68. a LO6 103. d

LO3 34. d LO3 69. d LO6 104. a

LO3 35. c LO4 70. d LO6 105. d
LO3 36. b LO4 71. b LO6 106. b
LO3 37. d LO4 72. a LO6 107. c
LO3 38. b LO4 73. c LO6 108. c

LO3 39. b LO4 74. d LO6 109. b

LO3 40. a LO5 75. b LO6 110. a
LO3 41. c LO5 76. a LO6 111. d
LO3 42. b LO5 77. d LO6 112. c
LO3 43. b LO5 78. b LO6 113. b

LO3 44. c LO5 79. c LO6 114. a

LO3 45. d LO5 80. a LO6 115. d
LO3 46. d LO5 81. b LO6 116. a
LO3 47. a LO5 82. a LO6 117. c
LO3 48. a LO6 83. d LO7 118. a

LO3 49. c LO6 84. b LO8 119. a

LO3 50. c LO6 85. d LO8 120. b
LO3 51. c LO6 86. a LO8 121. c
LO3 52. b LO6 87. d LO8 122. d
LO3 53. d LO6 88. c LO8 123. c

LO3 54. c LO6 89. b LO8 124. b

LO3 55. b LO6 90. a
LO3 56. b LO6 91. c
LO3 57. d LO6 92. c,b
LO3 58. b LO6 93. b

257
MULTIPLE CHOICE

56. Retail demand 100 + Dealer demand 200 = 300 units

57. Painting capacity 350 - Retail demand 150 = 200 units
60. (October $200,000 x 60% = $120,000) + (Beginning accounts receivable $40,000) =
$160,000
61. October $200,000 x 40% = $80,000
62. 200,000 x (1- 30%) = $140,000
63. Sales $200,000 – COGS $140,000 – Administrative costs $20,000 = $40,000
64. Beginning accounts payable $120,000
65. November sales $400,000 x (1 – 30%) = $280,000 COGS x 20% = $56,000
66. (May sales $60,000 x 70% = $42,000) + (June sales $75,000 x 30% = $22,500) = $64,500
67. (May purchases $30,000 x 60% = $18,000) + (June purchases $42,000 x 40% = $16,800) =
$34,800
68. (June sales $75,000 x 20% = $15,000) + (Cash operating costs $22,500 - $6,000 =
$16,500) = $31,500
69. (Cash June 1 $6,000 + cash collected from customers +$64,500 (See No. 66) – cash paid to
suppliers $34,800 (See No. 67) – operating expenses paid $31,500 (See No. 68) = $4,200 +
borrowed for minimum balance $1,500 = $5,700.
80. $7,200 / ($8.00 - $3.20) = 1,500 units
81. $1,600 / ($8.00 - $3.20) = 334 units
82. ($8.00 - $3.20) x (20,000 units) - $7,200 = $88,000
($7.20 - $3.20) x (22,000 units) - $7,200 = $80,800
Will decrease operating profit by $8,000
93. 1,000 units x $82 = $82,000
94. (1,000 units x $82) – (1,000 x $80) = $2,000 favorable variance
95. (1,200 units x $82) – (1,000 x $82) = $16,400 planning variance
100. Total direct material cost variance
= Actual direct material cost – Standard direct material cost
= (490# x $32) – (5,000 x 0.10# x $30) = $15,680 - $15,000 = $680 U
101. (AP – SP) x AQ = ($32 - $30) x 490# = $980 U
102. (AQ – SQ) x SP = [490# - (5,000 x 0.10#)] x $30 = $300 F
103. Planned quantity of containers was not disclosed.
104. (AR – SR) x AH = ($15.25 - $15.00) x 250 = $62.50 U
105. (AH – SH) x SR = [250 - (5,000 x 0.05)] x $15 = Zero variance
106. (AP – SP) x AQ = ($24 - $25) x 2,200# = $2,200 F
107. (AQ – SQ) x SP = [2,200# - (10,000 x 0.20#)] x $25 = $5,000 U
108. Total direct labor cost variance = Actual direct labor cost – Standard direct labor cost
= (1,050 x $14.75) – (10,000 x 0.10 x $15) = $15,487.50 - $15,000.00 = $487.50 U
109. (AR – SR) x AH = ($14.75 - $15.00) x 1,050 = $262.50 F
110. (AH – SH) x SR = [1,050 - (10,000 x 0.10)] x $15 = 750 U
111. Planned quantity of containers was not disclosed.
112. $600,000 / 25,000 units = $24 standard cost per unit x 20,000 actual units = $480,000
113. $450,000 expected capacity-related (fixed) costs from the master budget
114. Actual cost – Flexible cost = $512,000 - $480,000 (See No. 112) = $32,000 U

258
EXERCISE/PROBLEM

LO3
125. a. July Aug Sept
Retail production 4,000 4,000 6,000
Dealer production 8,000 8,000 6,000
Total production 12,000 12,000 12,000

b. During August and September, shop capacity is a limiting factor and shop capacity is
not being fully utilized.

If the company expects this demand trend to continue, Trafton Manufacturing may
want to consider renting additional space beginning in August to take advantage of
the increased demand and excess shop capacity at the end of the year.

LO3
126. a. Cash collections total $62,600 = Oct $18,224 + Nov $20,406 + Dec $23,970.

October November December

August $ 2,550
September 9,500 2,850
October 6,174 10,500 3,150
November 7,056 12,000
December 8,820
-------- --------- --------
$18,224 $20,406 $23,970

b. Cash disbursements total $25,200 = Oct $7,400 + Nov $8,400 + Dec $9,400.

October November December

September 4,200
October 3,200 4,800
November 3,600 5,400
December 4,000
-------- --------- --------
$7,400 $8,400 $9,400

259
LO3
127. Cash Inflows:
Cash collections from customers:
August (0.28 x $30,000) $8,400
September (0.50 x $20,000) 10,000
October (0.20 x $50,000) 10,000
Total $28,400

Cash Outflows:
Cash outflows for operating:
Suppliers ** $14,350
Labor 10,000
Operating costs 3,000
Total $27,350

Net cash flows this month $1,050

Opening cash 4,300
Cash dividends paid (10,000)
Cash from stock issue 6,000
Cash Available 1,350
Opening Loan 0
Borrowing Made 3,000
Borrowing Repaid 0
Ending Loan 3,000
Ending cash $4,350

**$7,350 + $7,000 = Oct (0.30 x $25,000 x .98) + Sept (0.70 x $10,000).

LO5
128. a. 2007 operating income equals $300,000 = $800,000 sales revenue - $200,000
variable costs - $300,000 fixed costs.

2007 breakeven point $400,000 in total sales dollars. $600,000 CM / $800,000 sales
revenue = 0.75 CM ratio. $300,000 total fixed costs / 0.75 CM ratio = $400,000 in
total sales to break even. OR $800,000 / 4,000 units = $200 selling price. $200,000 /
4,000 units = $50 flexible cost per unit. $300,000 / ($200 - $50) = 2,000 units to
break even.

b. $100,000 / 75% CM ratio = $133,334 in increased sales to break even. OR $100,000 /

($200 - $50) = 667 additional units to breakeven.

c. ($200 - $50) (4,000 units) - $300,000 = $300,000 current production and pricing
($196 - $45) (4,200 units) - $300,000 = $334,200 proposed production and pricing
Operating profit is expected to increase by $34,200

260
LO6
129. a. Total direct material cost variance.
= Actual direct material cost – Standard direct material cost
= (1,900# x $41) – (8,000 x 0.25 x $40)
= $77,900 - $80,000
= $2,100 favorable

b. Direct material price variance.

= (AP – SP) x AQ
= ($41 - $40) x 1,900#
= $1,900 unfavorable

c. Direct material quantity variance.

= (AQ – SQ) x SP
= [1,900# - (8,000 x 0.25)] x $40
= $4,000 favorable

d. Total direct labor cost variance.

= Actual direct labor cost – Standard direct labor cost
= (250 x $18.25) – (8,000 x 0.03 x $18)
= $4,562.50 - $4,320.00
= $242.50 unfavorable

e. Direct labor rate variance.

= (AR – SR) x AH
= ($18.25 - $18.00) x 250
= $62.50 unfavorable

f. Direct labor efficiency variance.

= (AH – SH) x SR
= [250 - (8,000 x 0.03)] x $18
= $180.00 unfavorable

261
LO6
130. a. Master Flexible Actual
Budget Budget Results
Sales volume (in units) # 30,000 # 25,000 # 25,000

Sales revenues $3,600,000 $3,000,000 $3,000,000

Flexible (variable) costs 2,160,000 $1,800,000 1,930,000

Contribution margin 1,440,000 $1,200,000 1,070,000

Capacity-related (fixed) costs 900,000 $ 900,000 970,000

Operating profit $ 540,000 $ 300,000 $ 100,000

b. Determine the flexible budget variance for flexible (variable) costs.

= Actual cost – Flexible budget cost
= $1,930,000 - $1,800,000
= $130,000 unfavorable

c. Determine the planning variance for flexible (variable) costs.

= Flexible budget cost – Master budget cost
= $1,800,000 – $2,160,000
= $360,000 favorable

d. As these results suggest, the manager should not be congratulated for keeping costs
under control. Flexible (variable) costs were $130,000 over budget for the actual
output achieved and capacity-related (fixed) costs were also $70,000 over budget.
These variances from the flexible budget highlight the amounts that are different than
planned. Since variances simply signal a deviation from what was planned, these
differences need to be investigated before corrective actions can be taken.

262
LO6
131. a. 1. For Material A, the favorable price variance indicates that the actual direct
material costs were lower than planned because the actual purchase price per
unit of raw material was lower than expected.

2. For Material A, the unfavorable quantity variance indicates that direct material
costs were higher than planned because more Material A was used during
production than was expected to be used for the actual output.

3. For direct labor, the unfavorable price variance indicates that direct labor costs
were higher than expected because the average wage paid per hour was greater
than planned.

4. For direct labor, the favorable efficiency variance indicates that direct labor
costs were lower than planned because fewer direct labor hours were used
during production than was expected to be used for the actual output.

b. It appears that both the $3,000 unfavorable Material A quantity variance and the
$2,500 favorable direct labor efficiency variance should be investigated by
management since these are greatest in magnitude. The unfavorable variance should
be investigated so that the cause of the problem can be identified and corrected. The
favorable variance should be investigated so that the favorable conditions may
possibly be replicated to continue these cost savings.

263
CRITICAL THINKING/ESSAY

LO1
132. What is budgeting? What is its role?
Solution: Budgeting is the process of preparing budgets, plans, schedules, and forecasts,
and the process requires several important skills, including forecasting, a knowledge of
how activities affect costs, and the ability to see how the organization's different activities
fit together.

The role of budgets includes planning, control, coordination of activities of organization,

problem signaling, communication of short-term goals to members and problem-solving
activities as organization control.

LO1
133. Describe the benefits to an organization of preparing an operating budget.
Solution: A well-prepared operating budget should serve as a guide for a company to
follow during the budgeted period. It is not “set in stone.” If new information or
opportunities arise, the budget should be adjusted.

A well-prepared operating budget assists management with the allocation of scarce

resources. It can help management see trouble spots in advance, and decide where to
allocate its limited resources.

A well-prepared operating budget fosters communication and coordination among various

segments of the company. The process of preparing a budget requires managers from
different functional areas to work together and to communicate performance levels they
both want and can attain.

A well-prepared operating budget can become the performance standard against which
firms can compare the actual results.

264
LO3
134. Describe operating and financial budgets and give at least two examples of each that are
discussed in the textbook.
Solution: Operating budgets specify the expected outcomes of any selling, capital
spending, manufacturing, purchasing, labor management, and administrative activities
during the planning period. Operations personnel use these plans to guide and coordinate
activities during the planning period.

Examples of operating budgets include the sales plan, capital spending plan, production
plan, materials purchasing plan, labor hiring and training plan, and the administrative and
discretionary spending plan.

Financial budgets are used to evaluate the financial consequences of a proposed decision.
They estimate the financial consequences of investment, production and sales plan
(identify financial consequences of activities summarized in operating budgets).

Examples of financial budgets include the projected balance sheet, projected income
statement, and projected cash flow statement.

LO3
135. Discuss the importance of the sales forecast and items that influence its accuracy.
Solution: All other budgets are based on information from the sales forecast.

The demand forecast is a challenge to predict because its accuracy depends on the ability to
forecast the state of the general economy, changes in the industry, actions of the
competition, the ability of the sales staff, and developments in technology. Each of these
items affects individual products or product lines and are quantified and aggregated to
obtain the forecast.

LO4
136. Discuss the terms discretionary expenditures and committed expenditures and give an
example of each.
Solution: Discretionary expenditures provide the infrastructure required by the emerging
production and sales plan. There is no direct relationship between the level of spending on
these activities and actual production levels. They do not supply capacity to produce but
support the organization’s strategy by enhancing performance potential.

Examples of discretionary expenditures include amounts spent on employee training

research and development, advertising and machine maintenance.

Committed expenditures are expensive. In addition, they are costs that are the same
whether the facility is used or not, and the level of these costs is very difficult to change in
the short term.

An example of a committed expenditure would be a payment on a long-term lease.

265
LO5
137. Explain when a manager would use what-if analysis.
Solution: What-if analysis is helpful for evaluating the effects of alternative marketing,
production, and selling strategies.

LO1
138. Are negative variances always unfavorable and positive variances always favorable?
Explain.
Solution: No. In identifying whether a variance is favorable or unfavorable, the focus should
not be on positive or negative answers. If actual costs are lower (higher) than expected costs,
the variance will be favorable (unfavorable). However, if actual revenues or income are
higher (lower) than expected, the variance will be favorable (unfavorable).

LO6
139. Explain what each of the following variances indicates, and discuss what conditions might
have caused each variance.
Direct material price variance: $1,000 U
Direct material use variance: $1,500 F
Direct labor rate variance: $800 F
Direct labor efficiency variance: $300 U
Solution:
Direct material price variance: $1,000 U An unfavorable variance indicates that the
materials used cost $1,000 more than expected. This could be the result of a faulty
standard, increases in the market price of the materials, the purchasing agent failing to
negotiate a good price, or the result of purchasing superior high quality materials.

Direct material quantity variance: $1,500 F A favorable variance indicates that less
material was used than expected. This could be caused by the use of higher quality
materials which resulted in less waste or a faulty standard.

Direct labor rate variance: $800 F A favorable variance indicates that the wage rate paid
per hour was lower than expected. This could be the result of using less experienced and,
therefore, lower-paid employees, an unanticipated decrease in wages for the company due
to excess labor availability or other employment market factors, or a faulty standard.

Direct labor efficiency variance: $300 U An unfavorable variance indicates that the
actual amount of time worked on the job was more than expected. This could be the result
of using less experienced and, therefore, more inefficient employees, or a faulty standard.

LO6
140. What is the primary role of the flexible budget?
Solution: The primary role of the flexible budget is to provide a realistic standard against
which to compare actual costs. The differences in revenues and costs between the master
budget and flexible budget reflect the effect of differences between the planned quantity
and the actual achieved output quantity. The differences in costs between the flexible
budget and actual costs reflect variances between actual costs and the expected standard
costs. It reflects the cost and revenue targets based on the actual level of volume.

266
LO7
141. How is the role of budgeting similar for a manufacturing firm and a not-for-profit
organization?
Solution: As in manufacturing firms, budgeting helps nonmanufacturing organizations
perform their planning function by coordinating and formalizing responsibilities and
relationships and communicating the expected plans.

LO8
142. Describe some of the drawbacks of using the operating budget as a control device.
Solution: When the operating budget is used as a control device, it can lead to behavior that
is actually detrimental to the organization.

The major problem with the budget performance report is not the report itself, but rather
the way it is used. In general, managers are rewarded for favorable variances, and
disciplined for unfavorable variances. This encourages managers to set lax standards for
both sales and costs so favorable variances result. It can also lead to “budget games.”

Another drawback is that, once the budget is established, if there is any variance between
budget and actual, it is assumed to be because of the actual results. However, as we know,
the budget will never be totally accurate due to the uncertainties of predicting the future.

If used properly, however, the operating budget can be a tremendous benefit to any
company.

LO8
143. What is stretch budgeting? Why is it used?
Solution: A stretch budget is one that exceeds a previous target by a significant amount and
usually requires an enormous increase in effort to achieve.

Research has shown that the most motivating type of budget is one that is "tight," meaning
targets are perceived as ambitious, but attainable. Stretch budgets push organizations to
improve so companies completely reevaluate ways to develop/produce products and
services.

267
LO8
144. What is budget slack? What are the pros and cons of building slack into the budget from
the point of view of (a) an employee and (b) a senior manager?
Solution: Budget slack occurs when subordinates (1) ask for excess resources above and
beyond what they need to accomplish budget objectives and (2) distort information by
claiming they are not as efficient or effective at what they do, thus lowering management's
performance expectations of them.

Employee's point of view: There are two benefits from this point of view. First, the
subordinate may be able to obtain excess resources to achieve desired goals. This may take
a lot of pressure off the subordinate and reduce job anxiety. Second, the subordinate may
be able to convince senior management to lower their work expectations of him or her.
This may also lead to lower pressure on the subordinate to perform. Both of these types of
slack-building are designed to reduce job stress for the subordinate. However, if incentives
are graduated in such a way that achieving higher and higher goals provides the
subordinate with more and more compensation in the form of bonuses, then the
subordinate may lose income by selecting lower goals.

Senior management's point of view: When subordinates build in slack, they are either
using unnecessary resources to achieve a goal that they should have been able to achieve
with fewer resources, or they are understating their performance capabilities. Thus, the
organization is either not running as efficiently as it can, or it is losing potential
productivity from employees who are not working as hard as they can. In some cases,
senior management may believe that subordinates build in slack to relieve job pressure. If
burnout of employees has been happening in the organization, then perhaps senior
management may be more forgiving and view some slack-building as necessary to keep
their employees from quitting.

268