 In this presentation we will discuss budget problems or potential pitfalls within the budgeting process that we want to be aware of that we want to avoid. One problem with the budget is that there is an inherent incentive within the budgeting process often to try to understate the sales that will be budgeted for and overstate the expenses. Why? First a word from our sponsor. Well actually these are just items that we picked from the YouTube Shopping Affiliate program but that's actually good for you because these aren't things that we're just given to us from some large corporation which we don't even use in exchange for us selling them to you these are things that we actually researched purchased and use ourselves. Bayer Dynamic? Not sure if I said that right but this is the DT770 Pro 250 OHM studio reference closed back headphones. 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Because that will make it easier to hit the target so if you're imagining the budget budgeting process as the management the upper management is there to of course approve the budgeting process communicate the process of making the budget and then we've got the managing department managers of each department and supervisors of each section of the company then coming up with their the budgets for their particular department their particular segment of the company those department managers have an incentive you would think to do things like understate the sales and overstate the expenses because if they do so on the budget then it'll be easier to hit that target and they'll look good to hit the target in other words if they overstate the sales that they're going to make in their department and understate the expenses which is that's what we would want we would want sales to be high we would want the expenses to be low then it'll be harder to hit that and if they don't hit the target then they look bad if they set a low target that's easy to hit low sales and high expenses then then higher lower sales and higher expenses then they know they can achieve then it'll be easier to hit the target and when they hit the target it will look better so that's just an inherent problem within the budgeting process and we have to be aware of it and we have to be aware of the fact that we want to make sure that we have motivated departments to basically set a budget that has a target that is not too high but achievable and we want to be able to incentivize management to set the target in a place that's reasonable so that they have the incentive so that they can inspire their department to shoot for a reasonable target rather than undershooting it and we have to basically make that part of the culture of the organization to say hey we're gonna we're gonna reward you more we're looking for for management that's looking to make a reasonable type of budget we'd rather have someone make a budget that's a little too high and miss it than make a budget that's going to be too low just so that they can hit it another problem inherent in the budgeting process is that we typically want to set those budgeting goals in such a fashion that there's going to be a challenging growth pattern in it so typically when we consider the budget we're considering a smooth growth trend that's what we like to see within the sales we want to see the sales we want to see the net sales going up in a nice smooth pattern another problem inherent to the budgeting process is that pressure could lead people to unethical behavior in other words we want to set the budget to a point that's going to be difficult for people to meet but still meetable and we often want to see some kind of trend that's going to be a normal kind of uptrend in process we want to see improvement over time continuous improvement over time and if there's going to be compensation objectives related to that such as bonuses for hitting a certain objective for hitting a certain mark that can also add to a lot of pressure to make that mark so as we set those high goals because we need those high goals for maximum performance we also need to be aware that people could be incentivized for unethical behavior and again it's got to be in the culture of the organization to be set that hey we would rather have someone miss the goal even though we set these goals and we want people to strive for them rather than do some unethical type of behavior in order to achieve the goal and possibly doing things that could be fraudulent or deceiving the reports or things that are going to sacrifice the long-term vision of the company in order to meet a short-term goal what we want what we don't want to have is have the long-term vision the five-year the 10-year being actually diminished or reduced or making it harder to reach because people are doing things that are going to manipulate or harm that long-term vision in order to meet the short-term goal simply because there's pressure of that short-term goal we want to keep the long-term vision in view inside and make sure that the culture of the organization sees that everything should line up with that long-term vision even though we're shooting at these short-term goals another problem inherent in the budget and we touched on this in the first item is that the budget could lead to spending an amount that's going to be equal to the expenses that are allocated to that department in other words if we are budgeted or allocated some amount of expenses that we can spend in a particular department then we're having an incentive to make sure that we spend everything that's allocated to our department because if we're not it's very likely that we will not be allocated that much in the future so in other words you might see spending that doesn't need to happen we might say hmm we need another plancher here we might need some more chairs here this often happens at the end of the time period at the end of the month or at the end of the budgeting period where you might see purchases that be in a bit in excess and it could be possibly because they're trying to make sure that they expend or spend all the money that has been allocated to them by the budget for that period so that in the next period they can argue that they need the same amount of money in other words there's not really an incentive oftentimes for us to spend less money that has been allocated budgeted to us because we know that the following budget the next budget that's going to be made is going to be based in part on the prior period and if we didn't spend all the money that was allocated to us in the prior period in our department it's likely that we will see less in the budget again we want to basically have communication within the budgeting process and make sure that we reward people for achieving their goals and making their goals and actually spending less in some way so I'll although the budgeting process has this problem kind of inherent in it because we do have to allocate some expenses to departments in some way we want to basically be aware of that and incentivize people recognize people notice people that are spending less than the amount allocated and find some way to reward that as well another problem with the budget is it's difficult to find the best range for the budget in other words we want to have a range that's going to be high enough to challenge people because that's where people maximize their performance we want people to be challenged that's when actually they feel better about themselves because they get to do something in a challenging fashion and try to meet an objective that is a challenge to them and of course that's where the company gets the most benefit as well but if you go too far on the goals and objectives and make them too difficult then that will discourage people and it will either stress them out or it will make them say hey you know what this is unachievable the goals and objectives that are always being put out there are things and goals and objectives that everybody knows are not achievable and that could lead to people just giving up and not trying at that point in time so on one side of the spectrum you have the goals and objectives being too low if they're too low you end up with people just basically relaxing and saying I can clear this objective no problem and not pushing themselves and when they're not pushing themselves you're actually hurting the employees a lot of times because they would actually benefit whether they would admit to it or not from a higher objective because they would be able to achieve something that is difficult for them and that usually gives benefit to the employees and of course obviously it's best for the company as well and again if the objectives are too high then you're going to discourage employees and they're either going to get frustrated they might leave or they're just going to say they're just going to stick around and just and just stop trying you'll end up with the same kind of scenario here with people not doing anything because either they get stressed out and they leave and replaced or they just say hey you know this the objectives that are given to us are always way too high there's no way anybody can meet them and therefore we might as well just do whatever we we can do here we don't have an either way and either side of the spectrum we don't have the incentive for people to really strive for the goal so what you want is to hit that that sweet spot for people and again every person is different so it's difficult to do but you want to hit that spot where people are really trying for the goal it's difficult for them and yet it's not too difficult it's not unachievable and that's always a balancing act within the budgeting process to recap then some of the problems with the budgeting process that we want to be aware of as we go through it is there could be an incentive to understate sales budget and overstate expense budget to look good and hit the target so there's an incentive for department managers to possibly lower the target of their budget to make something that would be easier to hit so we want to be aware of that and make a culture to deal with that and hopefully set up a culture so that people don't want to do that want to make challenging goals for themselves and the company there could be pressure could lead to unethical behavior to achieve goals so when we set those high goals again we want to make sure that there's a culture within the company that says hey we'd rather have you not meet the goal than sacrifice the long-term vision of the company or do anything that would be unethical budgets could lead to spending budget amount even though it is not necessary so budget is not reduced in other words it could lead to people saying hey this is how much was allocated for me to spend this period I'm going to spend that amount no matter what even if I don't have to so that next period I am allocated at least the same amount so we want to be aware of that that's going to be a natural incentive within the budgeting process again we want to set up a culture that says hey it would be good we will reward you we will recognize you if you do good if you if you surpass what is expected in terms of the spending budget and budgets that are not realistic can reduce morale while budgets that are too easy to meet will not inspire growth in other words we want to make that budget that's somewhere in the sweet spot that departments can say hey I can meet that I can meet that goal but it's difficult it's not something that I can easily meet it's something that's going to be challenging it's a challenge that people will hopefully want to take on and aspire to