Question

1. What is the main advantage of an object classification budget? What are its limitations? How do performance budgets overcome these limitations?

Answer 1

A uniform classification identifying the obligations of the federal government by the types of goods or services purchased (such as personnel compensation, supplies and materials, and equipment) without regard to the agency involved or the purpose of the programs for which they are used. If the obligations are in a single object classification category, the classification is identified in the Program and Financing Schedule in the President’s budget. For the activities distributed among two or more object classification categories, the budget has a separate object classification schedule to show the distribution of the obligations by object classification.

A major element of financial data activity rests in the act of budgeting. Budgeting is the process of allocating finite resources to the prioritized needs of an organization. In most cases, for a governmental entity, the budget represents the legal authority to spend money. Adoption of a budget in the public sector implies that a set of decisions has been made by the governing board and administrators that culminates in matching a government's resources with the entity's needs. As such, the budget is a product of the planning process.

The budget also provides an important tool for the control and evaluation of sources and the uses of resources. Using the accounting system to enact the will of the governing body, administrators are able to execute and control activities that have been authorized by the budget and to evaluate financial performance on the basis of comparisons between budgeted and actual operations. Thus, the budget is implicitly linked to financial accountability and relates directly to the financial reporting objectives established by the GASB.

The planning and control functions inherent to any organization, including schools, underscore the importance of sound budgeting practices for the following reasons:

• The type, quantity, and quality of goods and services provided by governments often are not subject to the market forces of supply and demand. Thus, enacting and adhering to the budget establishes restrictions in the absence of a competitive market.
• These goods and services provided by governments are generally considered critical to the public interest and welfare.
• The scope and diversity of operations in an organization make comprehensive financial planning essential for good decision making.
• The financial planning process is critical to the expression of citizen preferences and is the avenue for reaching consensus among citizens, members of the governing board, and staff on the future direction of the governmental unit's operations.

The link between financial planning and budget preparation gives the budget document a unique role in governmental organizations. Budgets in the public arena are often considered the definitive policy document because an adopted budget represents the financial plan used by a government to achieve its goals and objectives. When a unit of government legally adopts a financial plan, the budget has secured the approval of the majority of the governing board and reflects

• public choices about which goods and services the unit of government will or will not provide,
• the prioritization of activities in which the unit of government will be involved,
• the relative influence of various participants and interest groups in the budget development process, and
• the governmental unit's plan for acquiring and using its resources.

Performance evaluation allows citizens and taxpayers to hold policymakers and administrators in governmental organizations accountable for their actions. Because accountability to citizens often is stated explicitly in state laws and state constitutions, it is a cornerstone of budgeting and financial reporting. GASB recognizes the importance of accountability with the following objectives in GASB

• Financial reporting should provide information to determine whether current-year revenues were sufficient to pay for current-year services.
• Financial reporting should demonstrate whether resources were obtained and used in accordance with the entity's legally adopted budget. It should also demonstrate compliance with other finance-related legal or contractual requirements.
• Financial reporting should provide information to assist users in assessing the service efforts, costs, and accomplishments of the governmental entity.

Meeting these objectives requires budget preparation that is based on several concepts recognizing accountability. Accountability is often established by incorporating these objectives into legal mandates that require state and local public sector budgets to

• be balanced so that current revenues are sufficient to pay for current services;
• be prepared in accordance with all applicable federal, state, and local laws; and
• provide a basis for the evaluation of a government's service efforts, costs, and accomplishments.

Although some form of a balanced budget requirement is generally necessary to ensure long-term fiscal health in any organization, variations such as the use of fund balance reserves to pay for current services may be appropriate over a short period. Generally, however, all departures from this fundamental objective must be in accordance with applicable state and local laws and policies.

Given the importance of demonstrating compliance with the approved budget, the financial reporting system must control the use of financial resources and ensure that budgetary appropriations and allocations are not exceeded. To demonstrate compliance, accounting systems are usually operated on the same basis of accounting used to prepare the approved budget. Thus, the actual financial information captured by the accounting system is in a form comparable to the approved budget. Through budgetary integration, the financial accounting system becomes the primary tool to prove financial accountability.

Finally, the budget is evaluated for its effectiveness in attaining the organization's stated goals and objectives. Evaluation typically involves an examination of how funds were expended, the outcomes that resulted from the expenditure of funds, and the degree to which these outcomes achieved the stated objectives. This phase is fundamental in developing the subsequent year's budgetary allocations. In effect, budget preparation not only is an annual exercise to determine the allocation of funds, but also is part of a continuous cycle of planning and evaluation to achieve the stated goals and objectives of the organization.

Advantages and Limitations of Budgeting!

Advantages of Budgeting:

Budgeting plays an important role in the effective use of resources and achieving overall organisational goals.

Budgeting compels and motivates management to make an early and timely study of its problems. It generates a sense of caution and care, and adequate study among managers before decisions are made by them.

2. Budgeting provides a valuable means of controlling income and expenditure of a business as it is a “plan for spending.”

3. Budgeting provides a tool through which managerial policies and goals are periodically evaluated, tested and established as guidelines for the entire organisation.

4. Budgeting helps in directing capital and other resources into the most profitable channels.

5. Budgeting enables management to decentralise responsibility without losing control of the business. It reveals weaknesses, inefficiencies, deviations in the organisation very promptly which can be checked immediately to achieve a desired goal.

6. The use of budgeting in an organisation develops an attitude of “cost consciousness”, stimulates the effective use of resources, and creates an environment of profit-mindedness throughout the organisation. It emphasises how much should be spent to achieve a goal.

7. It provides a norm, basis or yardstick for measuring performance of departments and individuals working in organisations. Individual managers can evaluate their own decisions and achievements and take suitable steps to improve their performances.

8. Budgeting encourages productive competition, provides incentive to perform efficiently and gives a sense of purpose to each individual in the organisation. All these positive factors lead to higher output and increase employee productivity.

9. Budgeting provides a systematic and disciplined approach to the solution of problems in the organisation.

10. Budgeting, if executed in nearly every enterprise, helps the total national economy by providing stability of employment, economic use of resources and effective prevention of waste.

Limitations of Budgeting:

While budgeting performs many functions and has many advantages that are vital to an organi­sation, it has certain limitations which require careful consideration:

1. Planning, budgeting or forecasting is not an exact science; it uses approximations and judgement which may not be cent per cent accurate. At best, a budget is an estimate; no one knows precisely what will happen in the future.

2. The success and utility of budgeting depends on the cooperation and participation of all members of management. All persons should direct their efforts according to the plan. The top management also should adhere to the budget and provide cooperation. Many a time budgeting has failed because executive management has paid only lip service to its execution.

3. A budget is only a tool and neither eliminates nor takes over the place of management. A budget cannot be substituted for management but should only be used by management for accomplishing managerial functions. Executives generally feel “circled in” by a budget and its related figures. They fail to understand that budget is meant to provide detailed information, goals and targets which may help them in achieving the company objectives.

4. The establishment of a budgeting process taken time. Also, sometimes too much is expected from a budget and in case expectations are not fulfilled, the blame is put on the budget. An efficient budgeting programme requires that responsible persons should understand the philosophy, objectives and essentials of budgeting.

5. Excessive emphasis on budgeting may result in attempts by lower level management and employees to buck the system by providing inaccurate estimates of future costs and revenues, and by failing to take advantage of changes in the environment because to do so would result in a deviation from plan, they would be considered as operating contrary to the budget. Under an unbalanced budget programme, employees will tend to overestimate costs and underestimate revenues, thus creating budget slack.

6. As the end of budget period approaches and employees realise that actual expenses have not been as great as allowed by the budget, there may be a temptation to spend excessive amounts in order to “use up” the budget allowance. Such activities result in sub-optimal profits for the company.

Performance evaluation allows citizens and taxpayers to hold policymakers and administrators in governmental organizations accountable for their actions. Because accountability to citizens often is stated explicitly in state laws and state constitutions, it is a cornerstone of budgeting and financial reporting. GASB recognizes the importance of accountability with the following objectives in GASB

• Financial reporting should provide information to determine whether current-year revenues were sufficient to pay for current-year services.
• Financial reporting should demonstrate whether resources were obtained and used in accordance with the entity's legally adopted budget. It should also demonstrate compliance with other finance-related legal or contractual requirements.
• Financial reporting should provide information to assist users in assessing the service efforts, costs, and accomplishments of the governmental entity.

Meeting these objectives requires budget preparation that is based on several concepts recognizing accountability. Accountability is often established by incorporating these objectives into legal mandates that require state and local public sector budgets to

• be balanced so that current revenues are sufficient to pay for current services;
• be prepared in accordance with all applicable federal, state, and local laws; and
• provide a basis for the evaluation of a government's service efforts, costs, and accomplishments.

Although some form of a balanced budget requirement is generally necessary to ensure long-term fiscal health in any organization, variations such as the use of fund balance reserves to pay for current services may be appropriate over a short period. Generally, however, all departures from this fundamental objective must be in accordance with applicable state and local laws and policies.

Given the importance of demonstrating compliance with the approved budget, the financial reporting system must control the use of financial resources and ensure that budgetary appropriations and allocations are not exceeded. To demonstrate compliance, accounting systems are usually operated on the same basis of accounting used to prepare the approved budget. Thus, the actual financial information captured by the accounting system is in a form comparable to the approved budget. Through budgetary integration, the financial accounting system becomes the primary tool to prove financial accountability.

Finally, the budget is evaluated for its effectiveness in attaining the organization's stated goals and objectives. Evaluation typically involves an examination of how funds were expended, the outcomes that resulted from the expenditure of funds, and the degree to which these outcomes achieved the stated objectives. This phase is fundamental in developing the subsequent year's budgetary allocations. In effect, budget preparation not only is an annual exercise to determine the allocation of funds, but also is part of a continuous cycle of planning and evaluation to achieve the stated goals and objectives of the organization.