Totem Ltd uses participative budgeting where managers who are responsible for meeting budgets also prepare the initial budget forecasts. The company has a policy of giving bonuses to the managers if they can complete the project within the budgeted cost. John is a manager of Totem Ltd, who is be responsible for managing project A this year. 

The chief financial officer asked John to provide a cost forecast for project A. After careful consideration John estimated that the total cost for project A will be $60,000. However, in his report to the chief financial officer, John mentioned that the total estimated cost for project A is $75,000.

 

Required:

1) What is this practice of intentionally setting cost budgets too high called? 

2) Provide two reasons why John reported a different cost for project A than the estimated amount? Discuss whether his action was ethical?

3) Suggest three steps the chief financial officer of Totem Ltd can take to minimise this practice of managers overstating budgets?