A departmental or divisional budget often is used as the basis for evaluating a managers performance. Actual

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Question:

A departmental or divisional budget often is used as the basis for evaluating a manager’s performance. Actual results are compared with budgeted performance levels, and those who outperform the budget often are rewarded with promotions or salary increases. In many cases, bonuses are tied explicitly to performance relative to a budget. For example, the top-management personnel of a division may receive a bonus if divisional profit exceeds budgeted profit by a certain percentage.

Serious ethical issues can arise in situations where a budget is the basis for rewarding managers. For example, suppose a division’s top-management personnel will split a bonus equal to 10 percent of the amount by which actual divisional profit exceeds the budget. This may create an incentive for the divisional budget officer, or other managers supplying data, to pad the divisional profit budget. Such padding would make the budget easier to achieve, thus increasing the chance of a bonus. Alternatively, there may be an incentive to manipulate the actual divisional results in order to maximize management’s bonus. For example, year-end sales could be shifted between years to increase reported revenue in a particular year. Budget personnel could have such incentives for either of two reasons: (1) they might share in the bonus or (2) they might feel pressure from the managers who would share in the bonus.

Put yourself in the position of the division controller. Your bonus, and that of your boss, the division vice president, will be determined in part by the division’s income in comparison to the budget. When your division has submitted budgets in the past, the corporate management has usually cut your budgeted expenses, thereby increasing the division’s budgeted profit. This, of course, makes it more difficult for your division to achieve the budgeted profit. Moreover, it makes it less likely that you and your divisional colleagues will earn a bonus.

Now your boss is pressuring you to pad the expense budget, because “the budgeted expenses will just be cut anyway at the corporate level.” Is padding the budget ethical under these circumstances? What do you think? And how could you resolve the situation?