It means inflating the amount in a budget so that any unexpected cost of the project can be recovered in the future while executing the projects. It is a method of artificially increasing the amount in expected project cost.
It’s a deliberate process where the actual forecast by the budget preparer differs from the submitted forecast to the authority. The difference between the padded estimate and realistic estimate is known as budget slack.
Example of Budget Padding
A company may plan for the construction of a building over a period of 3 years. The expected and calculated construction cost for the company is $1,000,000 and the company has a policy of a 20% mark up on construction cost.
So total construction revenue quotation will be $1,200,000. In this case, the fluctuation in cement cost, material, and labor cost may happen over the period of 3 years. So, the builder will already plan and include the impact of inflation in all the construction costs.
Let’s assume that after the inclusion of inflation in construction cost, the final cost is $1,100,000. So according to the policy of the company construction revenue quotation will be $ 1,320,000.
Many times, it is considered unethical by many practitioners. However, the practitioners defend it on the ground that practically the real world has unexpected situations and every situation cannot be predicted in advance.
This is done by either reducing the expected revenue or increasing the expected expenditures.
Benefits of budget padding
Economic factors need to be considered in the case of budget padding. In the event of expected inflation budget padding can be helpful. In case the company has international projects based upon which the company is going to receive foreign currency in the future.
In this case, budget padding may help if exchange rate fluctuations arise. Even if some unexpected expense arises, padding gives it a chance to cover that unexpected cost.
Favorable impression in the eyes of senior management
If the company proposes a larger budget and the executive team outperforms that budget it is viewed as a positive performance by bosses.
For example, a divisional manager’s annual bonus is 2% of all the savings done by his division. Let’s assume that the projected total expenditure for his division is $500,000. However, he used budget padding practice and presented a report in front of management showing an expected cost of $600,000.
In this case, when the annual performance evaluation will be done, the divisional manager can claim that he had saved $100,000 ($600,000-$500,000) for the company and he can claim a bonus of $ 2,000 ($100,000 * 2%).
At the same time management would also appreciate his efforts for savings of $100,000 for the company. In this was this is also a deceptive practice. If any unexpected expense arises, padding provides slack so that unexpected expenses can be covered up.
Fear of budget cut
Many managers think that in case there is a budget cut by management it can put additional pressure on executing team.
For example, a company planned expenditure of advertisement of $90,000 in 3 platforms via. print media, social media, and tv advertisement. So, it was decided to have an allocation of $30,000 for each advertisement platform.
However later on management reduced the overall budget from $90,000 to $60,000 only. In this case, the executives have to allocate $20,000 to each advertisement platform and cut down their original budgeted advertisement expenses.
So, to prevent such a situation, the executive could have used budget padding practice by originally inflating the budget expenditure $ 90,000 to let’s say $120,000. Later on, even if there is a budget cut from the management, the executives would have a sufficient amount of money for advertisement.
Theoretically, expenditure on any project should be based upon the actual budget so that impact of budget padding can be removed.
Many people consider budget padding as a deceptive technique. There are ethical issues about not providing accurate details by the executives of the company to senior management. These ethical issues may lead to trust problems among them in the future.
Budget padding aims to get high funding from the approval committee in advance.
Political aspects of budget padding
The preparer and beneficiaries get illegal fund advantage from budget padding. Along with salaries and allowances, it keeps the political structure of the people involved very strong.
This practice is used by certain lawmakers without the knowledge of their colleagues. In many cases, these funds are used for phony projects which don’t have any existence in real life. It creates an opportunity for the lawmaker to divert funds for private use.
This provides illicit enrichment from public funds by diverting the resources, underestimating economic progress. Many political patronages now receive their political patronage through budget padding. The Nigerian economy is a classic example of budget padding which happened in 2016.
In Nigeria, there were corrupt practices that have reduced the growth rate of that country’s foreign direct investments. Although Nigeria is the largest producer of crude oil, more than 60% of people still live below the poverty line.
Conclusively, the budget padding harmed the Nigerian economy in terms of effective output, impact on foreign exchange, GDP of their country, imports or exports, etc.
Budget padding may or may not be used by many executives in their routine business decisions. However, it should not negatively affect the overall goals and growth of the organization.