Budgeting is an essential process for all businesses. By using the company’s current financial data as well as its historical data, a business should be able to forecast and plan a budget for the company’s future. A budget is defined as “a statement of monetary plans that is prepared in advance of a forthcoming period, usually one year” (Brookson 2000). This budget should align with the company’s strategic and operational plans and is the tactical implementation of the company’s business plan. Since the company’s budget is controlled by all levels of the company’s management, the company budget is usually an aggregate compilation of the departmental budgets. Budgets are used to help establish a company’s sales forecast, product pricing, as well as assist in investment planning. Budgets are also used by management for motivation and performance evaluation. A manager’s performance evaluation will usually relate to their contracted compensation plan and will be paid as a bonus in addition to their salary. These incentives are usually based on a percentage of meeting or exceeding budgeted or targeted goals which are established and controlled by management. Because of management’s control of the numbers, budgets and targeted goals are easily manipulated in order to increase the manager’s compensation. When this process occurs, it is known as “gaming” the system.
Gaming the System
Managers have been known to game the system when their personal incentives seem more attractive than the benefits of the organization. Gaming the system occurs when an organization’s explicit policies and procedures are being used which managers feel are obstacles in achieving the organization’s goals. “By flexing the policies and procedures, employees are about to ensure that they can continue to work in an environment in which they are rewarded for the work that they do. However, in so doing, they are gaming the system that is supposed to ensure organizational effectiveness” (Rieley 2000). Many managers game the system because they know their target is unreachable. According to Steve Pugh, CEO of CODA Financials, “when executives feel free to demand a 15 percent revenue increase mapping out how to reach that target, the budget might be padded or otherwise "gamed" by each manager before it's passed down the line. ‘By the time it gets to the lowest manager," concludes Pugh, "the 15 percent mandate has grown to 35 percent, and every manager knows it's padded and an irrelevant target’” (Leone 2003). In order for these managers to feel in control of their numbers, they begin implementing biased-based budgeting. This type of budgeting not only allows the managers to control the numbers but it assists them in achieving their target goals thus rewarding them for their performance.
Biased Budgeting System
Because the budgeting process is an essential element of the management control system, upper management should become...