CMA Exam: Planning and Budgeting Question 2

“Along with success comes a reputation for wisdom.” Euripides

The Question

Budgetary Slack can be best described as:

A) The planned overestimation of budgeted expenses
B) The elimination of certain expenses to enhance budgeted income
C) The planned underestimation of budgeted expenses
D) A plug number used to achieve a pre-set level of operating income

The Analysis

A budget is a financial plan of the future, normally one year or less. Managers at all levels of an organization prepare budgets each month, quarter, or year depending on the budget methodology. The budget should always be an accurate reflection of the best estimates of how much revenue an organization will achieve in a given period, all the expenses it’ll incur to generate that revenue, and the difference between the two which is the operating income.

It’s common practice to measure a manager’s or division’s performance by how closely they meet their budget figures in terms of sales, expenses, and profit. This practice ensures top management that everyone is doing their part in meeting the overall strategic goal of the organization. The hazard of measuring performance solely on budget targets is that managers may add to their budgets what is known as Budgetary Slack.

Budgetary Slack is the practice of underestimating budgeted revenues and overestimating budgeted expenses to create a “cushion” against unforeseen circumstances. This may help managers achieve their budget targets, but may make it very difficult for top management to make sound business decisions as budgetary slack distorts the figures of what the organization could actually achieve in terms of revenue growth and profit.

The best approach to prevent budgetary slack from creeping into budgets is to use the budgeting system as a planning and control tool, but not for managerial performance evaluation.

The Answer

A) The planned overestimation of budgeted expenses

This is the correct answer. Overestimation of budgeted expenses is a characteristic of budgetary slack.

B) The elimination of certain expenses to enhance budgeted income

By artificially eliminating expenses from a budget to enhance budgeted income would increase the risk of not meeting budget targets. This is not the correct answer.

C) The planned underestimation of budgeted expenses

Underestimating budgeted expenses is counter to budgetary slack. In budgetary slack, budgeted expenses are overestimated and budgeted sales underestimated. This is not the correct answer.

D) A plug number used to achieve a pre-set level of operating income

In budgetary slack, budgeted expenses are overestimated and budgeted sales underestimated. This is not the correct answer.

 

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Thank you,
Nathan

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