Budgetary slack refers to the deliberate adjustment of additional cash outlays in expectation of future cash flow. The people involved in creating a budget intentionally underestimate the amount of revenue or overestimate the amount of expenses. For example, if a plant manager believes that the cost of raw materials will be RM250,000 but gives a budgetary projection of RM300,000, the manager has built in RM50,000 of slack into the budget. Budgetary slack is most common when a company uses participative budgeting.
It involves the participation of a large number of employees which gives them more chances to introduce budgetary slack into the budget. They may set budget standards that are too loose and hence, easily to achieve target. There are few reasons why managers practice budgetary slack. 1) Self-interest behavior of managers.
When the top management placed heavy pressure upon lower level managers who prepare budget, they create budgetary slack to make the budget look achievable so they can avoid the burden of failure.
Managers want to look successful in terms of budgetary performance by creating a lower performance benchmark relative to their actual capabilities to receive favourable evaluation and reputation in the top management. Managers have incentive to overestimate project costs that builds in budgetary slack. This allows the project manager to present the finished project as coming in under-budget. If the real cost of the project turns out to be lower than the exaggerated cost projection, the manager will be perceived as being capable to manage the project in a cost-efficient manner.
2) Information asymmetry
Information asymmetry forms a favourable condition for slack creation. Managers acquire more private information because they are closer to the decision environment than their superiors. Managers present a distorted picture of business possibilities to their superiors and create budgetary slack by preventing the disclosure of all the information to the top management. From the example above, the manager may obtain information that other supplier offers a lower price of raw materials and hide the information during the preparation budget.