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Role Playing to Understand Some Consequences of Budgeting

Role Playing to Understand Some Consequences of Budgeting. Based on a Case by Norman Sheehan In Accounting Perspectives , 2008. Scenario I: Will you produce 340 Units for the Special Customer Order? . You are a factory worker paid by the hour making paper planes.

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Role Playing to Understand Some Consequences of Budgeting

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  1. Role Playing to Understand Some Consequences of Budgeting Based on a Case by Norman Sheehan In Accounting Perspectives, 2008

  2. Scenario I: Will you produce 340 Units for the Special Customer Order? • You are a factory worker paid by the hour making paper planes. • The plant manager approaches you on Friday regarding next week’s production (you only work Monday to Friday). • Her records show you have been averaging 300 planes per week, but a large, important customer needs 340 planes guaranteed by the end of your shift next Friday. • The plant manager needs to know if you can make these planes (with no overtime) so that she can commit to the customer, ensure that you have the extra supplies you need, and confirm that the shipping department will be ready to ship the order. • Read your private information…

  3. Private Information: • In a bad week, you produce 280 planes • In an average week, you produce 300 planes, which is the average to date and what the plant manager knows. • In a “good” week you produce 320 planes. • However… • You know you can produce 340-345 planes/week if you really apply yourself. • You also have some production ideas (a new folding technology) that you are pretty sure will allow you to improve to 350 planes/week

  4. Now, regarding the plant manager’s request… • Do you agree to produce 340 units next week?

  5. Anecdote from Oracle CEO* • Oracle’s dashboard system allows founder and CEO Larry Ellison and other senior managers to monitor how many sales leads each salesperson has (or has not) been able to convert into a sale. • One continuing frustration is that although all of Oracle’s 20,000 salespeople use dashboards, some 20 percent refuse to enter their sales leads into the system • Why are they reluctant to share their sales leads with senior management? • Ellison is frustrated: withholding information “makes it hard to get a true picture of the demand for Oracle’s products. *Ante, Spencer E., and Jena. McGregor , “Giving the Boss The Big Picture,” Business Week, 2/13/2006, Issue 3971

  6. Scenario II: How Many Units Will You Volunteer for Next Year’s Budget? • You are (still) a factory worker who is paid by the hour making paper planes. You are the only worker who does this particular job. • The week after the special order of 340 planes, the plant manager approaches you regarding next year’s budget. • She needs to know how many units per week she should budget for the next year — what do you answer?

  7. Scenario III: What if Senior Management Unilaterally Adjusts the Budget Upward? • You are (still) a factory worker who is paid by the hour making paper planes. • The week after the special order of 340 units, the plant manager approaches you regarding next year’s budget. • You know from before that senior management routinely adds 10 percent to your stated total — what do you answer?

  8. Scenario IV: What if You Anticipate Management Will Implement a Bonus System? • You are (still!) a factory worker who is paid by the hour making paper planes. • The week after the special order of 340 units, the plant manager approaches you regarding next year’s budget. • A reliable source informs you that management will introduce a bonus system next year that pays $2 for each plane produced over budget — what do you answer?

  9. Justify your answers • Who said less than 300? • What do you anticipate you actually will produce? • Will producing 40-50 extra units/week have a positive or negative effect on the company?

  10. Managing the Tension between Using Budgets for Planning and Control • “Almost every company uses a budget system that rewards people for lying and punishes them for telling the truth. Indeed, in some cases, the more managers lie, the more money they make. (Michael Jensen, “Manager’s journal: Why pay people to lie?” Wall Street Journal, January 8, 2001) • How do we resolve this issue in practice?

  11. Thoughts from Hope & Frazier • Traditional budgeting is a fixed-performance contract. Once a year, employees must commit and are held accountable. • Many undesirable side effects, including enticing employees to pad their budgets in the face of uncertainty. • Propose using two separate systems: • for planning, a 12–18 month rolling forecasts updated every 90 days. • for control and evaluation purposes, benchmark an employee’s performance (or a unit’s) against internal or industry standards. • By separating planning and control, • senior management receives timely and relevant information for planning . • Benchmarks motivate employees to meet/beat performance of their peers inside or outside the company. • Hope J., and R. Fraser. 2003a. Who needs budgets? Harvard Business Review 81 (2): 108–14. • Hope J., and R. Fraser. 2003b. New ways of setting rewards: The Beyond Budgeting model. California Management Review 45 (4): 104–19.

  12. Budgetary Slack and Professional Ethics • Is padding one’s budget acceptable ethically? • If not, who will be hurt? • “Honest” departments that have not padded their budgets • The organization due to suboptimal allocation of resources • You, by going to Hell!(kidding!) • Do professional accountants working in industry have greater responsibility to truthfully reveal their productive capacities than factory workers?

  13. Codes of Ethics • Most professional accounting bodies in the world belong to the International Federation of Accountants, whose Code of Ethics for Professional Accountants contains the following: • 110.1 The principle of integrity imposes an obligation on all professional accountants to be straightforward and honest in professional and business relationships. Integrity also implies fair dealing and truthfulness. • 110.2 A professional accountant should not be associated with reports, returns, communications or other information where they believe that the information: • (a) Contains a materially false or misleading statement; • (b) Contains statements or information furnished recklessly; or • (c) Omits or obscures information required to be included where such omission or obscurity would be misleading.

  14. The role of professionals in society. • Society grants professionals such as accountants, lawyers, doctors, and engineers the legal right to govern their practice, restrict entry to the profession, and organize themselves. • In return, professionals have a duty to safeguard and advance society’s best interests • Abiding by ethical principles

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