Why does budget need to be controlled

This method budgets by organizational unit and object and is consistent with the lines of authority and responsibility in organizational units. As a result, this approach enhances organizational control and allows the accumulation of expenditure data at each functional level.

Finally, line-item budgeting allows the accumulation of expenditure data by organizational unit for use in trend or historical analysis. Although this approach offers substantial advantages, critics have identified several shortcomings that may make it inappropriate for certain organizational environments.

The most severe criticism is that it presents little useful information to decisionmakers on the functions and activities of organizational units. Since this budget presents proposed expenditure amounts only by category, the justifications for such expenditures are not explicit and are often unintuitive.

In addition, it may invite micro-management by administrators and governing boards as they attempt to manage operations with little or no performance information. However, to overcome its limitations, the line-item budget can be augmented with supplemental program and performance information. Performance Budgeting A different focus is seen in performance budgeting models. In a strict performance budgeting environment, budgeted expenditures are based on a standard cost of inputs multiplied by the number of units of an activity to be provided in that time period.

The total budget for an organization is the sum of all the standard unit costs multiplied by the units expected to be provided. Although this strict approach may be useful for certain types of operations, many organizations require a more flexible performance approach. For example, expenditures may be based simply on the activities or levels of service to be provided and a comparison of budgeted and historical expenditure levels. The performance approach is generally considered superior to the line-item approach because it provides more useful information for legislative consideration and for evaluation by administrators.

Further, performance budgeting includes narrative descriptions of each program or activity-that is, it organizes the budget into quantitative estimates of costs and accomplishments and focuses on measuring and evaluating outcomes. Finally, the performance approach eases legislative budget revisions because program activities and levels of service may be budgeted on the basis of standard cost inputs.

However, performance budgeting has limitations owing to the lack of reliable standard cost information inherent in governmental organizations. Further, the performance approach does not necessarily evaluate the appropriateness of program activities in relation to reaching an organization's goals or the quality of services or outputs produced.

Consequently, the performance approach has become most useful for activities that are routine in nature and discretely measurable such as vehicle maintenance and accounts payable processing -activities that make up only a relatively modest part of the total educational enterprise.

But in sum, performance budgeting may offer considerable enhancement to the line-item budget when appropriately applied. Program and Planning Programming Budgeting PPB Program budgeting refers to a variety of different budgeting systems that base expenditures primarily on programs of work and secondarily on objects.

It is considered a transitional form between traditional line-item and performance approaches, and it may be called modified program budgeting. In contrast to other approaches, a full program budget bases expenditures solely on programs of work regardless of objects or organizational units.

As these two variations attest, program budgeting is flexible enough to be applied in a variety of ways, depending on organizational needs and administrative capabilities. Program budgeting differs from approaches previously discussed because it is much less control- and evaluation-oriented. Budget requests and reports are summarized in terms of a few broad programs rather than in the great detail of line-item expenditures or organizational units. PPB systems place a great deal of emphasis on identifying the fundamental objectives of a governmental entity and on relating all program expenditures to these activities.

This conceptual framework includes the practices of explicitly projecting long-term costs of programs and the evaluation of different program alternatives that may be used to reach long-term goals and objectives.

The focus on long-range planning is the major advantage of this approach, and advocates believe that organizations are more likely to reach their stated goals and objectives if this approach is used.

However, several limitations exist in the actual implementation of this approach, including changes in long-term goals, lack of consensus regarding the fundamental objectives of the organization, lack of adequate program and cost data, and the difficulty of administering programs that involve several organizational units.

As with performance budgeting, PPB information may be used to supplement and support traditional budgets in order to increase their informational value. Zero-Based Budgeting The basic tenet of zero-based budgeting ZBB is that program activities and services must be justified annually during the budget development process. The budget is prepared by dividing all of a government's operations into decision units at relatively low levels of the organization.

Individual decision units are then aggregated into decision packages on the basis of program activities, program goals, organizational units, and so forth. Costs of goods or services are attached to each decision package on the basis of the level of production or service to be provided to produce defined outputs or outcomes.

Decision units are then ranked by their importance in reaching organizational goals and objectives. Therefore, when the proposed budget is presented, it contains a series of budget decisions that are tied to the attainment of the entity's goals and objectives. The central thrust of ZBB is the elimination of outdated efforts and expenditures and the concentration of resources where they are most effective.

This is achieved through an annual review of all program activities and expenditures, which results in improved information for allocation decisions. However, proper development requires a great deal of staff time, planning, and paperwork.

Experience with the implementation of this approach indicates that a comprehensive review of ZBB decision packages for some program activities may be necessary only periodically. Additionally, a minimum level of service for certain programs may be legislated regardless of the results of the review process.

As a result, ZBB has had only modest application in schools, although the review of program activities makes ZBB particularly useful when overall spending must be reduced. Site-Based Budgeting Site-based budgeting is widely considered the most practical for budgeting within the school district environment, by providing greater control and reporting of school-level data. This budgetary approach which may be used in combination with any of the four discussed above emphasizes the decentralization of budgetary decisionmaking.

Site-based budgeting places local managers and other staff at the center of the budget preparation process, making them responsible for both the preparation and the maintenance of the budget. Site-based budgeting is popular in many school settings. Within a school system, site-based budgeting generally involves granting increased budgetary authority to the school.

Resources are allocated to the site, with budget authority for programs and services granted to the school's principal and staff. Campuses are normally allocated a certain level of resources that they have the authority to allocate to educational and support services. These budgetary allocations are meant to cover those areas over which campus decisionmakers have control.

For example, schools that have authority over staffing decisions may be allocated funds for staff costs using the site-based budgeting approach. In contrast, school districts that make staffing decisions centrally may not allocate funds to the individual school site for staff costs.

The main advantage of site-based budgeting is that those who best understand the needs of a particular organization are empowered to make resource allocation decisions. This decentralization of budgetary authority may also increase local accountability.

Another potential advantage of site-based budgeting is the increased level of participation of the public and staff in budget development.

Many site-based budgeting systems create committees composed of staff and community members to determine budgetary allocations. These committees give members a voice from the inception of the budget process, rather than merely when the budget is presented for public review and approval.

Although site-based budgeting may provide substantial benefits, it also has limitations. Participation is not the answer to all the problems of budget preparation. However, it is one way to achieve better results in organizations that are receptive to the philosophy of participation. Skip to main content.

Chapter 7: Budgeting. Search for:. Top management, then, must clearly state long-range goals and broad objectives. These goals and objectives must be communicated throughout the organization. Long-range goals include the expected quality of products or services, growth rates in sales and earnings, and percentage-of-market targets.

Overemphasis on the mechanics of the budgeting process should be avoided. Employees are more likely to strive toward organizational goals if they participate in setting them and in preparing budgets. Often, employees have significant information that could help in preparing a meaningful budget. Also, employees may be motivated to perform their own functions within budget constraints if they are committed to achieving organizational goals.

Communicating results People should be promptly and clearly informed of their progress. Effective communication implies 1 timeliness, 2 reasonable accuracy, and 3 improved understanding. Managers should effectively communicate results so employees can make any necessary adjustments in their performance. Flexibility If significant basic assumptions underlying the budget change during the year, the planned operating budget should be restated.

For control purposes, after the actual level of operations is known, the actual revenues and expenses can be compared to expected performance at that level of operations. Follow-up Budget follow-up and data feedback are part of the control aspect of budgetary control.

Since the budgets are dealing with projections and estimates for future operating results and financial positions, managers must continuously check their budgets and correct them if necessary.

Often management uses performance reports as a follow-up tool to compare actual results with budgeted results. You will review some specific examples of budgeting for direct materials in Prepare Operating Budgets.

Figure shows how operating budgets and financial budgets are related within a master budget. The Role of Operating Budgets An operating budget consists of the sales budget, production budget, direct material budget, direct labor budget, and overhead budget.

These budgets serve to assist in planning and monitoring the day-to-day activities of the organization by informing management of how many units need to be produced, how much material needs to be ordered, how many labor hours need to be scheduled, and the amount of overhead expected to be incurred. The individual pieces of the operating budget collectively lead to the creation of the budgeted income statement. Management understands that it needs to have on hand the 1, trainers that it estimates will be sold.

It also understands that additional inventory needs to be on hand in the event there are additional sales and to prepare for sales in the second quarter.

This information is used to develop a production budget. Each trainer requires 3. Knowing how many units are to be produced and how much inventory needs to be on hand is used to develop a direct materials budget. The direct materials budget lets managers know when and how much raw materials need to be ordered. The same is true for direct labor, as management knows how many units will be manufactured and how many hours of direct labor are needed.

The necessary hours of direct labor and the estimated labor rate are used to develop the direct labor budget. While the materials and labor are determined from the production budget, only the variable overhead can be determined from the production budget.

Existing information regarding fixed manufacturing costs are combined with variable manufacturing costs to determine the manufacturing overhead budget. The information from the sales budget is used to determine the sales and administrative budget. Finally, the sales, direct materials, direct labor, fixed manufacturing overhead budget, and sales and administrative budgets are used to develop a pro-forma income statement. A financial budget consists of the cash budget, the budgeted balance sheet, and the budget for capital expenses.

Similar to the individual budgets that make up the operating budgets, the financial budgets serve to assist with planning and monitoring the financing requirements of the organization.

Management plans its capital asset needs and states them in the capital expense budget. Management addresses its collection and payment policies to determine when it will receive cash from sales and when it will pay the material, labor, and overhead expenses.

The capital expense budget and the estimated payment and collection of cash allow management to build a cash budget and determine when it will need financing or have additional funds to pay back loans. These budgets taken together will be part of the budgeted balance sheet.

Figure shows how these budgets relate. DaQuan recently began work as a senior accountant at Mad Coffee Company. How can DaQuan determine potential cash balance issues by looking at the budget? Budgeting helps plan for those times when cash is in short supply and bills need to be paid.

Proper budgeting shows when and for how long a cash shortage may exist. Knowing the inflow and outflow of cash will help him plan and manage the shortage through a line of credit, delay in purchasing, delay in hiring, or delay in payment of non-essential items. Budgeting is a task that should be completed by all organizations, not only those limited to manufacturing. Unfortunately, there are many individuals who want to operate a business and know nothing about budgeting.

Often, professional organizations or industry trade groups offer information to help their members succeed in business. For example, the real estate profession provides information and suggestions such as this article on preparing a marketing budget to help professionals.

Figure Which of the following is not a part of budgeting? Figure Which of the following is an operating budget? Figure Which of the following is a finance budget? Figure Which approach is most likely to result in employee buy-in to the budget? Figure Which approach requires management to justify all its expenditures?

Figure Which of the following is true in a bottom-up budgeting approach? Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification.

I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Business Essentials Guide to Mergers and Acquisitions. Business Business Essentials. What Is Cost Control? Key Takeaways Cost control is the practice of identifying and reducing business expenses to increase profits, and it starts with the budgeting process. Outsourcing is a common method to control costs because many businesses find it cheaper to pay a third party to perform a task than to take on the work within the company.