Behavioural aspects of budgeting: formula sheet

Key formulas

Goal congruence

Manager's personal aims = Organisation's aims

Budgets and reward systems should push managers towards what is best for the whole organisation.

Budgetary slack

Slack = Budgeted cost allowance − Cost actually needed

Slack is deliberately built in by managers. It makes targets easy and wastes resources.

Motivation rule of thumb

Best motivation: targets that are challenging but achievable and accepted

This is a general tendency, not a guaranteed result. Individuals differ.

Controllability rule

Judge managers on controllable items only

Uncontrollable costs should be separated in reports or excluded from the manager's assessment.

Cost slack

Cost slack = Budgeted cost − Realistic (needed) cost

A positive figure means the budget is padded. Use it when the question gives you both figures.

Revenue slack

Revenue slack = Realistic revenue − Budgeted revenue

A positive figure means sales were understated in the budget.

Slack as a percentage

Slack % = Slack ÷ Realistic figure × 100

Divide by the realistic figure, not the padded budget, unless the question says otherwise.

Ideal standard

Assumes perfect conditions, no allowance for waste, idle time or breakdowns

Usually unattainable. Adverse variances are expected, which can demotivate. Useful as a long-term aim.

Attainable standard

Efficient working with allowance for normal losses, waste and downtime

Challenging but achievable. Generally best for motivation.

Easy (low) standard

Can be reached with little effort, often based on past performance

Little motivation to improve. Encourages slack.

Controllable cost

A cost a manager can influence by their own decisions in the period

Judge managers on these. Controllability depends on the manager and time frame.

Controllable profit (responsibility reporting)

Controllable profit = Revenue − Controllable costs

Uncontrollable items such as allocated head office costs are excluded or shown separately.

Quick revision

• A budget can motivate or demotivate, depending on how it is set and used.
• Top-down budgets are set by senior management with little input from managers.
• Participative budgets are set with input from the managers who must meet them.
• Participation can improve commitment, accuracy and motivation, but takes more time.
• Budgetary slack means deliberately overstating costs or understating revenue to make a target easier.
• Slack makes budgets less accurate and can waste resources.
• Targets that are too easy give little motivation; targets that are too hard can lead to giving up.
• A challenging but achievable target is generally best for motivation.
• Managers should be judged on items they can control; uncontrollable items are better reported separately.
• Flexed budgets help make comparisons fairer when activity differs from plan.
• Focus on short-term budget results can cause poor long-term decisions.

Common mistakes

• Saying tougher targets always improve performance. Fix: Remember the target must be achievable and accepted. Very tight targets can demotivate and encourage cheating.
• Saying participation always motivates and has no downside. Fix: Always pair participation with the risk of budgetary slack and possible time cost.
• Mixing up top-down and bottom-up. Fix: Top-down means orders come from the top (imposed). Bottom-up means proposals start with budget holders (participative).
• Saying participation always gives better budgets. Fix: Always give both sides. Participation takes time, allows slack and can produce targets that clash with company goals.
• Saying slack means a budget that is too tight. Fix: Remember slack means looseness. It makes the budget easier to achieve, not harder.
• Treating slack as only an overstatement of costs. Fix: Slack also includes understating revenue or output targets. Check both sides.
• Saying ideal standards are best because they push managers hardest. Fix: Remember that targets seen as impossible reduce effort. Attainable standards are usually best for motivation.
• Saying attainable standards allow no waste. Fix: Ideal means no waste or downtime. Attainable allows normal waste and delays.
• Treating participation as a cure-all with no downsides. Fix: Remember that participation can encourage slack, since managers may pad budgets they helped set.
• Confusing slack with a genuine forecast error. Fix: Slack is deliberate. Look for words such as overstated, cushion or padded.

Exam tips

• Objective questions often describe a behaviour and ask for its cause. Match the behaviour to the budget feature first.
• Know both sides of participation: commitment and better information against slack and time cost.
• Do not choose absolute answers such as 'always' or 'never' unless the scenario clearly supports them.
• For number entry on slack, subtract the cost actually needed from the allowance given.
• In multiple response questions, select exactly the number stated and avoid ticking extra options.
• Read whether the question asks for advantages or disadvantages. Many wrong options are true points about the opposite.
• In multiple response questions, select exactly the number stated. Do not add an extra option that merely sounds sensible.
• Distinguish clearly between true participation and pseudo-participation when a scenario mentions managers being consulted.