Corporate Finance – Budgeting
Joy Reed, a district manager, performance evaluation and reward is made on the basis of adhering to the confines of a flexible budget.
Joy, the assistants, and operation managers are all eligible to receive a bonus if actual district net operating income is between budgeted net operating income and 130 per cent of the net operating income.
The bonuses are based on a fixed percentage of actual net operating income. Net operating income greater than 130 per cent of budgeted net operating income earn a bonus at the 130 per cent level (in short, there is an upper limit on bonus payments). If actual net operating income is less than budgeted net operating income, no bonuses are awarded. Consider actions taken by Joy:
- Joy overestimates expenses and underestimates revenues. This increases the chances of the district in reaching the budgeted net operating income. Joy believes the action is okay, because it increases the probability of receiving bonuses and helps keep the managers morale high.
- Near fiscal year end, Joy sees the district will not achieve budgeted net operating income. So, she tells the sales group to defer the closing several sales agreements to the next fiscal year. She also wrote off inventory which was worthless. Deferring revenues to following year and writing off inventory in a no-bonus year increases the probability of a bonus for next
- Make the assumption that towards the end of the year, Joy sees actual net operating income will exceed the 130 per cent limit and she takes actions similar to those described in Item
Although there are ethical issues to address, there are additional concerns impacted by ethical lapses in decision making, such as the budgeting and impact on the various parts of the organization, or the
The following are required for discussion:
Discuss Joy’s ethical behavior; are her actions right or wrong? What role does the company play in enabling the actions taken by Joy?
If you are the marketing manager for the district, and receive instructions to defer closing of sales until the next fiscal year, what would you do?
If you are the operations manager, and know your budget has been padded by the district manager and the padding is common knowledge among other operations managers, who support it because it increases the probability of coming under budget and receiving a bonus, what would you do?
If you are the district controller, and receive instructions from the district manager to accelerate the recognition of expenses which legitimately belong to a future period, what would you do?
