ACCT338 Topic Three Budget

ISSUES OF BUDGETING AND
CONTROL Topic Three
ACCT338 Not-for-Profit Accounting
Learning Objectives
The key purpose of budget
The various ways of classifying expenditures
The key phases of the budget cycle
The limitation of the budget actual comparisons
How budget enhance control
Budget and accounting systems
Budget
Budgeting is the process of allocating
scarce resources to unlimited demands.

Budget is a dollars and cents plan of
operation for a specific period of time.
Introduction
Budgets are key financial instruments.
National Council on Governmental Accounting
(NCGA) statement 1, Government accounting and

financial reporting principles, para 77, 1979:
Budgeting is an essential element of financial
planning, control, and evaluation processes of
governments. Each government unit should prepare a
comprehensive budget covering all governmental,
proprietary, and fiduciary funds for each annual fiscal
period.
Introduction
Governments and not-for-profits are disciplined mainly
by their budget, not by the competitive market place.

Budgets of governments have the force of law
Attention to words:
Legislatures
of
governments
appropriate
funds
for
expenditure.
The
board of trustee of a private-sector not-for-profits
authorizes or approves outlays.

What are the key purposes of

Budgets?
Budgets are intended to fulfill three board
functions:
1. Planning
2. Controlling
3. Evaluating

Budgets?
Planning comprises
Programming: determining the activities that
the entity will undertake.

Resource acquisition
Resource allocation

Budgets?
Planning is concerned with specifying the type,
quantity, and quality of services that will be
provided to constituents; estimating service
costs, and determining how to pay for the
services.

Budgets?
Controlling
Budgets help ensure that resources are obtained
and expended as planned.

Legislative bodies or board of trustees, use budgets
to impose spending authority over executives.

Executive in turn use budgets to impose authority
over their subordinates.


Budgets?
Evaluating
Budgets lay the foundation for end-of-period reports
and evaluations.
Budget-to-actual comparisons reveal whether revenue
and spending mandates were carried out. compliance

Budgets, when tied to organization objectives, can
facilitate assessment of efficiency and effectiveness.
10
Why is more than one type of

budget necessary?
A well managed G or NP should prepare budgets for varying
periods of time from multiple perspectives:

1.
Appropriation budgets
2.
Capital budgets
3.
Flexible budgets
4.
Performance budget
11

budget necessary?
Appropriation Budgets
the legislatively approved budget that grants
expenditure authority to departments and other
governmental units in accordance with
applicable laws.
12

budget necessary?
Appropriation Budget
Concerned with current operating revenues and
expenditures.
A government current or operating budget covers its
general fund.
The
operating
budget
is
almost
always
an
appropriation budget.
In most jurisdictions, the operating budget must
always be balanced.
13

budget necessary?
Capital Budgets
Focuses on the acquisition and construction of long
term assets.
Although the accounting cycle is traditionally one
year, the budgeting process may extend for a

considerably longer period.
The needs of organization constituents must be
forecast and planned for years in advance.

14

budget necessary?
Capital Budgets
Capital budget covers multiple years, as many as five.
It concentrates on the construction and acquisition of long
lived assets, such as
land, buildings, roads, bridges, and
major items of equipment.

These assets can be expected to last for many years.
Therefore, in the interest of interperiod equity, they will be

financed with long term debt rather than taxes of a single
year.
15

budget necessary?
Capital Budgets
Capital budget is a plan setting forth when specific capital
assets will be acquired and how they will be financed.

Capital budgets are closely tied to operating budgets
Each year, a government must include current-year capital

spending in its operating budget.
If the capital projects are financed with debt, the CAPEX will
be offset with bond proceeds and will not affect the
operating budget.
16

budget necessary?
Flexible Budgets which relate costs to
outputs and are thereby intended to help
control costs, especially those of businesstype activities.
17

budget necessary?
Flexible Budgets
Enterprise funds, which account for business type
activities, are generally not subject to the same

statutory
budget
requirements
as
governmental
funds.
Governments should prepare the same types of
budgets for enterprise fund as would a private

enterprise carrying out similar activities.
18

budget necessary?
Flexible Budgets
Governments should prepare flexible budgets, each of which
contains alternative budget estimates based on varying

levels of output.
Flexible
budgets
capture
the
behavior
of
costs,
distinguishing fixed and variable amounts.

Flexible budgets are especially suited for enterprise funds in
which the level of activity depends on customers' demand.
19

budget necessary?
Fixed budgets may be appropriate for
governmental funds expenditures and level of
activity are pre-established by legislative
authorization
20
How
are
expenditure
revenues classified
and
GASB advised that multiple classification of

governmental expenditure data is important
form both internal and external management
control and accountability standpoints.
21
How
are
expenditure
revenues classified
and
Suggested classifications include:

By Fund: such as general fund, special revenue fund, debt service
funds.
By Organizational Unit: such as police department, fire department,
city council.
By Function or Program: a group of activities carried out with the
same objective, such as public safety, sanitation, recreation.
22
How
are
expenditure
revenues classified
and
Suggested Classification include:

By Activity: line of work contributing to a function or program such
as highway patrol, crime investigation, vice patrol.

By Character: the fiscal period they are presumed to benefit such as
(Current, Capital, Debt Service)

By Object classification: the type of items purchased or the services
offered such as salaries, fringe benefits, travel, and repairs.
23
How
are
expenditure
revenues classified
and
Revenues present less significant issues of classification.

GASB recommended that, in fund statements, revenues
be classified first by fund, and then by source.

Major suggested revenue sources include:
Taxes (property tax, sales tax, hotel tax)
Licenses and Permits
Intergovernmental Revenues
Charges for Services
Fines and Forfeits
24
Why are performance budgets

necessary?
Object classification budget Example page 86
The traditional and most commonly prepared budget
It is characterized by the expenditure classification that
categorizes objects.
Facilitates control It has an expenditure control orientation.
25

necessary?
Drawbacks of object classification budget
Discourages planning. Top managers will focus on specific line items
rather than an overall entity objectives.

Promotes bottom-up budgeting than top-down budgeting, each unit
presenting its fiscal requirements for approval in the absence of

coordinated set of goals and objectives.
Overwhelms top-level decision-makers with details increasing all
expenditure by a fixed percentage.

Limits post-budget evaluation, because it fails to relate inputs with outputs.
26

necessary?
Performance budgets
Supplement to object classification budgets
Focus on measurable units of efforts, services and
accomplishments
Institutionalize effective decision process
The most common type of performance budget is
program budget.
27

necessary?
Program budgets Example page 87
Resources and results are identified with programs
rather than traditional organizational units, and
expenditures are typically categorized by activity
rather than object.
28
What are the

budget cycle?
key
phases
of
Budgeting practices in government and not-
for-profits are not standardized

Budget is a continuous four phases process
1. Preparation
2. Legislative adoption and executive approval
3. Execution
4. Reporting and auditing
This part should be

read in details form
the book
29
On what basis of accounting are

budgets prepared?
Despite the importance of the budget, neither
GASB
nor
FASB
establish
principles
for
budgeting. only for financial reporting

Budgetary
principles
are
established
by
individual governments or organizations, or by

governments of organizations that supervise
them.
30

budgets prepared?
GASB recommends that governments prepare
their budget for governmental funds on the

modified accrual basis.
Many governments reject the GASBs advice,
they prepare budgets on a cash basis or

modified cash basis.
31

budgets prepared?
Governments using cash basis/modified cash basis:
Assign revenues and expenditures to the period during which the
cash is expected to be received or disbursed.

Treat encumbrances commitments to purchase goods or
service equivalent of actual purchases.

Recognize taxes and other revenues in the year in which they are
due and not in the year in which they are expected to be

collected.
32

budgets prepared?
Rationale for budgeting on the cash basis:
In the face of balanced budget, the cash basis is
to ensures that the government receives in taxes
and other revenues only what it is required to
disburse.
33

budgets prepared?
Adverse consequences of the cash basis:
May distort the economic impact of planned fiscal activities.
May be unbalanced as to economic costs and revenues.
It may give an appearance of a budget that has achieved interperiod
equity when it really has not.

Makes it easier to transfer resources from a fund that has a budget
surplus to one that needs extra resources.

Complicates financial accounting and reporting.
34
What cautions must be taken in

budget to actual comparisons?
Whereas
the
GASB
specifies
the
principles
of
accounting to which governments must adhere on their

governmental funds, it is silent on those they can use
in preparing their budgets.
Unless a government reports its actual results using
budgetary principles, or its budget using generally

accepted accounting principles, a comparison between
the budget and actual results would not be meaningful.
35
What cautions must be taken in

budget to actual comparisons?
Statement No.34, GASB requires tat governments
present their budget-to-actual comparisons on a

budgetary basis and include a schedule that reconciles
the budgetary and the GAAP amounts.
Difference between Legally adopted budgets and
GAAP-based financial statements are caused by

differenced in:
1. Basis of accounting
2. Timing
3. Perspective
4. Reporting entity
36
Differenced
between
financial statements
budget
and
1.Basis of accounting : G often prepare their
budget on cash or modified cash basis, whereas

financial statements are prepared on a modified
accrual basis.
2.Timing: government may appropriate resources
for a particular project rather than for a particular

period. By contrast, the annual report of the fund
would present expenditures year by year.
37
Differenced
between
financial statements
budget
and
3. Perspective: governments may structure their budgets

differently from their financial reports.
Government may budget on the basis of programs, programs may be

financed by resources accounted for in several funds. Thus the amount
expended in each fund can not be compared to any particular line item
in the budget.
4. Reporting entity: GAAP requires that a governments

reporting entity include organizations that are legally
independent of the government, yet, in political or economic
reality, an integral part of it. Since this entity is independent,
the government may exclude it from its legally adopted
budget.
38
How does budgeting in not-for-profit

organizations compare with that in
governments?
Not-for-profit sector covers organizations that range
from those that depend entirely, or almost entirely, on

donor contributions, to those that run much like
business.
The budgeting process must be custom designed to suit
each particular type of entity.

NP must adjust the level of services they provide to the
corresponding level of revenues.

39
How does budgeting in not-for-profit

organizations compare with that in
governments?
Budget cycle is: preparation, adoption, execution,
reporting and auditing.

Not-for-profits are not subject to the same penalty for
violating the budget.
40
How
do
control?
budgets
enhance
G and NP can build safeguards into their accounting
systems that help ensure budgetary compliance.

The basic books are: Journals and Ledgers.
ESTIMATED REVENUES (DB) ACTUAL REVENUES (CR) = REVENUE TO BE

RECOGNIZED
APPROPRIATIONS (CR)-ACTUAL EXPENDITURES (DR) = BALANCE AVAILABLE FOR
EXPENDITURE
41
What are the distinctive ways

governments
record
their
budgets?
A school district adopts a budget calling for total revenues
of $400 m and total expenditure of $390 m.
The entries below would be made only to control accounts:
Dr. Estimated revenues
400
Cr. Fund Balance

Dr. Fund Balance
Cr. Appropriations
400
390
390
42

governments
record
their
budgets?
Suppose that during the year, revenues and expense were
exactly as estimated
Dr. Cash
400
Cr. Revenues
400
Dr. Expenditure 390

Cr. Cash
390
43

governments
record
their
budgets?
AT year end, each of the budgeted and actual revenues
and expenditure accounts would be closed
OR
Dr. Appropriations
Dr. Appropriations
390
Dr. Fund Balance
Cr. Expenditure
10
390
Cr. Estimated Revenues

Dr. Revenues
400
400
Cr. Expenditure
Cr. Fund Balance
390
390
10
Dr. Revenues
400
Cr. Estimated revenues

400
44

governments
record
their
budgets?
Suppose that during the year, revenues and expense were
$420 m, and $415 m, respectively
Dr. Cash
420
Cr. Revenues
420
Dr. Expenditure 415

Cr. Cash
415
45

governments
record
their
budgets?
Closing entries
Dr. Appropriations
390
Dr. Fund Balance
10
Cr. Estimated Revenues

Dr. Revenues
400
420
Cr. Expenditure
Cr. Fund Balance
415
5
Please read the book

to study the T
accounts
46

governments
record
their
budgets?
Alternative way by using budgetary fund balance.
In
this
way,
fund
balance
will
reflect
genuine
transactions, not forecasts.
47
How
does
accounting
overspending?
encumbrance
prevent
Encumbrances are
commitments to purchase
goods or services
48
How
does
accounting
overspending?
encumbrance
prevent
G and NP record encumbrances to help prevent
over spending the budget.

The entry to record an encumbrance is usually
prepared when a purchase order is issued or a

contract is signed, or a commitment is made.
Example:
when
university
makes
faculty
appointment for a year.
49
How
does
accounting
overspending?
encumbrance
prevent
The entry to record encumbrance reduces the
budgeted amount available for expenditure, as if

the amount had already been spent.
The entry to record encumbrance assigns a
portion of what would otherwise be unreserved

fund balance as reserve for encumbrances.
50
How
does
accounting
overspending?
encumbrance
prevent
Budgetary entries and encumbrances are mainly
internal control devices.

Encumbrances are of slightly greater concern to
external parties since they have a minor impact

on the basic financial statements.
51
How
does
accounting
overspending?
Outstanding
encumbrance
prevent
commitments
at
year
end
are
reported on the entitys fund balance sheet as a

reservation
of
fund
balance
and
accordingly
reduce the unreserved portion of fund balance.
52
How
does
accounting
overspending?
encumbrance
prevent
Example: a university contracts for repair services

that it estimates will cost $5,000.
Dr. Encumbrances
5,000
Cr. Reserve for encumbrances
5,000
53
How
does
accounting
overspending?
Reserve
encumbrance
prevent
for encumbrances is a balance sheet account, a
reservation of fund balance

Encumbrance account is most definitely not an expenditure, but it
is similar to an expenditure.
At year end, and remaining balance in the encumbrance account
is closed in the unreserved fund balance.

Encumbrance account indicate the amount that was transferred
during the period from unreserved fund balance to fund balance

reserved for encumbrances.
54
How
does
accounting
overspending?
encumbrance
prevent
S1: the repairs are completed and, as anticipated,

the university is billed $5,000.
Dr. Expenditure
5,000
Cr. Accounts Payable
5,000
The reserve for encumbrance is no longer required
Dr. Reserve for encumbrances

Cr. Encumbrances
5,000
5,000
55
How
does
accounting
overspending?
encumbrance
prevent
S2: assume the contractor completes the repairs but

bills the university for only $4,800.
1
2
Dr. Expenditure
4,800
4,800

Cr. Encumbrances
5,000
5,000
56
How
does
accounting
overspending?
encumbrance
prevent
S3: assume that in the current period the contractor completes

only 40% of the repairs and accordingly billed the university
$2,000. it expects to fulfill the remainder of the contract in
the following period.
Dr. Expenditure
2,000
2,000
Only 2,000 of the reserve for encumbrance will be reversed,
the university has an outstanding commitment for $3,000.

Cr. Encumbrances
2,000
2,000
57
How
does
accounting
overspending?
S3:
at
year
end,
encumbrance
prevent
the
expenditures
and
the
encumbrances would be closed to fund balance.

Dr. Fund Balance
5,000
Cr. Expenditure
2,000
Cr. Encumbrances
3,000
$3,000 of the university fund balance remains

reserved for encumbrances.
58
How
does
accounting
overspending?
encumbrance
prevent
S3: at the start of year two, the university had

$3,000 of outstanding commitments for repairs
reverse
the
closing
balance
to
restore
the
encumbrances for repairs:
4Dr. Encumbrances
Cr. Fund Balance
3,000
3,000
59
How
does
accounting
overspending?
encumbrance
prevent
S3: when the contractor completes the repairs:

Dr. Expenditure
3,000
Cr. Accounts payable
3,000

Cr. Encumbrances
3,000
3,000
60
How
does
accounting
overspending?
encumbrance
prevent
Impact of encumbrances on Fund Balance

Year 1: As of Jan 1, the university fund balance is
cash $1,000
Fund Balance $1,000
During the year, the university orders $1,000 supplies.
Dr. Encumbrances
1,000
Cr. Reserve for encumbrances
11,000
61
How
does
accounting
overspending?
encumbrance
prevent

Part of the supplies order costing $800 is received and
paid for cash
Dr. Supplies Expenditure
800
Cr. Cash 800

Cr. Encumbrances
800
800
62
How
does
accounting
overspending?
encumbrance
prevent

The university prepares the following entry at year 1
end:
Dr. Fund balance -Unreserved1,000
Cr. Encumbrances
200
Cr. Expenditure
800
63
How
does
accounting
overspending?
encumbrance
prevent

Year
2:
the
university
expects
to
honor
its
commitment for the supplies on order

Dr. Encumbrances
200
Cr. Fund Balance-unreserved 200
64
How
does
accounting
overspending?
encumbrance
prevent

The university receives and pays the remainder of
supplies, the additional charge was $150.
Dr. Supplies Expenditure
Cr. Cash
150

Cr.
150
Encumbrances
200
200
65
How
does
accounting
overspending?
encumbrance
prevent

At year 2 end,
Dr. Fund Balance-unreserved 150
Cr. Supplies expenditure
150
Please read the T accounts and the statements form the

book
66

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ACCT338 Topic Three Budget

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ISSUES OF BUDGETING AND

CONTROL Topic Three

ACCT338 Not-for-Profit Accounting

scarce resources to unlimited demands.

operation for a specific period of time.

ACCT338 Not-for-Profit Accounting

(NCGA) statement 1, Government accounting and

by their budget, not by the competitive market place.

board of trustee of a private-sector not-for-profits

authorizes or approves outlays.

What are the key purposes of

ACCT338 Not-for-Profit Accounting

What are the key purposes of

the entity will undertake.

ACCT338 Not-for-Profit Accounting

What are the key purposes of

ACCT338 Not-for-Profit Accounting

What are the key purposes of

and expended as planned.

to impose spending authority over executives.

over their subordinates.

What are the key purposes of

and spending mandates were carried out. compliance

facilitate assessment of efficiency and effectiveness.

ACCT338 Not-for-Profit Accounting

Why is more than one type of

periods of time from multiple perspectives:

ACCT338 Not-for-Profit Accounting

Why is more than one type of

ACCT338 Not-for-Profit Accounting

Why is more than one type of

ACCT338 Not-for-Profit Accounting

Why is more than one type of

year, the budgeting process may extend for a

forecast and planned for years in advance.

Why is more than one type of

lived assets, such as

land, buildings, roads, bridges, and

major items of equipment.

Therefore, in the interest of interperiod equity, they will be

Why is more than one type of

assets will be acquired and how they will be financed.

Each year, a government must include current-year capital

Why is more than one type of

ACCT338 Not-for-Profit Accounting

Why is more than one type of

activities, are generally not subject to the same

budgets for enterprise fund as would a private

Why is more than one type of

contains alternative budget estimates based on varying

distinguishing fixed and variable amounts.

which the level of activity depends on customers' demand.

ACCT338 Not-for-Profit Accounting

Why is more than one type of

ACCT338 Not-for-Profit Accounting

GASB advised that multiple classification of

ACCT338 Not-for-Profit Accounting

Suggested classifications include:

same objective, such as public safety, sanitation, recreation.

ACCT338 Not-for-Profit Accounting

Suggested Classification include:

as highway patrol, crime investigation, vice patrol.

(Current, Capital, Debt Service)

offered such as salaries, fringe benefits, travel, and repairs.