Barry Clarion, new-accounts manager at East Bank of New Hampshire, has been asked to project how many new accounts he will open during 20x2. The local economy has been growing, and the bank has experienced a 10% increase in the number of new accounts over each of the past five years. In 20x1, the bank had 10,000 accounts.Clarion is paid a salary, plus a bonus of $20 for every new account above the budgeted amount. Thus, if the annual budget calls for 1,000 new accounts, and 1,080 new accounts are obtained, his bonus will be $1,600 (80 × $20).Clarion believes that the local economy will continue to grow at the same rate in 20x2 as it has in recent years. He decided to submit a projection of 700 new accounts for 20x2.Required: Your consulting firm has been hired by the bank president to

Question

make recommendations for improving the bank's operation. Write a memorandum to the president defining and explaining the negative consequences of budgetary slack. Also discuss the bank's bonus system for the new-accounts manager and how the bonus program tends to encourage budgetary slack.

What will be an ideal response?

Answer 1

Memorandum
Date: Today
To: President, East Bank of New Hampshire From: I.M. Student and Associates
Subject: Budgetary slack

Budgetary slack is the difference between a budget estimate that a person provides and a realistic determination of the amount. The practice of creating budgetary slack is called padding the budget. The primary negative consequence of slack is that it undermines the credibility and usefulness of the budget as a planning and control tool. When a budget includes slack, the amounts in the budget no longer portray a realistic view of future operations.

The bank's bonus system for the new-accounts manager tends to encourage budgetary slack. Since the manager's bonus is determined by the number of new accounts opened in excess of the budgeted number, there is an incentive for the manager to understate his activity projections. There is evidence of this behavior, as a 10% increase over the bank's current 10,000 accounts would be 1,000 new accounts in 20x2. Clarion's projection, however, is only 700.